Real Estate Investment Trusts: Public vs Private

Real Estate Investment Trusts (REITs) are an asset category with a long history of solid investment returns that do not always demonstrate a direct correlation to the rest of the investment universe.   They have served as an excellent diversifier when combined with other traditional investments.

REIT’s are companies that own or finance properties that produce an income.  These properties can range from commercial real estate across many industries such as manufacturing locations, residential real estate rentals, hospitals, office parks, storage parks and strip malls, etc.    Most REITs function in a relatively simple to understand manner.   The cash flow from the rented properties pass thru to the owners of the REIT, which can be anyone who wishes to invest.  They are organized under a tax code that requires that they distribute at least 90% of their taxable income to the shareholders as dividend income.  As a result, REITs typically produce a dividend income stream that is favorable when compared to many other investment options.

There are several types of REITs, such as;

Equity REITs: which own properties directly to realize the rental cash flow.

Mortgage REITs: which aid in the financing of these properties by issuing loans, or purchasing loans on properties to realize the cash flow from the mortgage payment.

However, a more important distinction is the difference between publicly traded REIT’s and private REIT’s.

Public REITs are investments that must be registered with the Securities Exchange Commission, and comply with various reporting requirements such as filing a public quarterly report in order to provide transparency.   Many of these public REITs are some very well know names with brand recognition such as Public Storage or Simon properties.  There are also many public REITs that are not as well known to the general non-investing public.

Because these investments trade on a public exchange, they are highly liquid and can be sold daily during normal trading hours.   As an investor you can assess the value of your holding in a highly efficient market daily.  It is not uncommon to find dividend yields in this asset class of 4%-6% annually.

Private REITs are investments that are not subject to the same reporting requirements, and are only required to file their initial public offering with the Securities Exchange Commission.  As a result of the reduced compliance and regulatory burden, it is not unusual to find higher dividend cash flows associated with the private investments than can commonly be close to an 8% annual dividend yield.

However, there is often a significant upfront cost usually used to compensate the selling agent and the firm distributing the shares publicly, which can be as much as 10%, and sometimes more.  The larger concern is that of liquidity.   Due to the fact that these securities do not trade on a public exchange, trying to assess their day to day value is often quite difficult.   So while an investor may not feel that they are experiencing the daily fluctuations associated with the stock market in which public investments trade, their asset values are still changing daily.  This is somewhat analogous to being asked what the value of your home would be on a specific day.  You may be able to give a good estimate based on your knowledge of the community, but the true value cannot be determined until you find a willing buyer.

Publicly traded financial markets not only help us understand the value of our investments instantly by constantly matching buyers and sellers, a process known in economics as price discovery.   They also produce a high degree of liquidity by bringing many investors together in one location   One of the larger challenges with private REITs is that they offer no such regular price discovery after they have been issued, and therefore liquidity can be a significant concern.

It is not uncommon for private REITs to place many restrictions on the redemption and liquidation of these assets.   In some cases an investor must wait for a year or two before they can take any redemptions at all.  It is also common that investors can be restricted to taking redemptions at specific points, such as quarterly or annually.  These redemptions are often offered at no more than the original offering or less.  There have also been cases in which investors have been told that redemptions are totally suspended, and they can withdraw nothing until notified otherwise.   These types of restrictions are perfectly legal in a private security.

This is not to suggest that all private REITs perform poorly.  Some have done quite well.   However, investors looking to invest in such securities should be well aware of the potential lack of liquidity.  They should also be sure to do their research on the management team and the properties being purchased.  Such investments require enhanced due diligence without a relatively efficient public market that should already reflect all available information in the price.

Investors that are averse to having their funds tied up for an unknown duration of time should look to the public market for such investments.  In doing so, there is still a degree of due diligence that must be done when buying an individual public REIT to insure that the company meets with your risk tolerance.  Investors concerned with diversity to minimize this risk can invest directly into a mutual fund or an exchange traded fund that tracks the REIT marketplace.

As an example, the FTSE Nareit Index of REITs is comprised of more than 160 holdings primarily in the US marketplace.   The FTSE EPRA Nareit Global Index of REITs is a market index that is made up of over 290 holdings globally, with approximately 40% of them outside the United States.   These market benchmarks or similar benchmarks can be acquired through various investment funds that offer exposure to a marketplace of REITs with quite a bit of diversity, and significant liquidity at a very nominal cost.

Each individual has their own set of unique financial circumstances that may or may not benefit from different investment vehicles.  As with any investment product, it is advisable that you consult with your financial planner or investment professional in order to complete the proper due-diligence before investing in REITs, or any other investment vehicle.