When venturing into Real Estate investing, there are several primary ways to go about it. Each have some benefits and drawbacks. Here we are going to dive in and take a look at the differences between Real Estate Investment Trusts (REITs) and Direct Investment.
Investing in REITs
Investing in a REIT is a way to “diversify” into real estate. However, when you invest in a REIT you do not actually own real estate, but rather you own a share of stock in a company. The following are notable attributes of REIT investing:
A private REIT can charge up to 17% up-front before your investment even touches the real estate. For every $100 you invest, less than $85 goes towards the real estate. Additionally, a REIT is only required to distribute 90% of the income generated by its properties back to investors, significantly lowering overall returns.
REIT shares are stocks traded on public exchanges, so they are subject to the high volatility of the stock market.
Lower Average Returns
The average publicly traded REIT dividend is 3.4%, significantly lower than the average returns generated by direct commercial real estate ownership, which typically generate cash returns ranging from 6% to 10% annually.
Lack of Control
A REIT is designed to provide for real estate investing what mutual funds provide for stock investing- diversification and low barrier to entry. Although there is a diversity of assets, there is also a lack of control over which assets are being purchased.
Although REITs have strict reporting guidelines, most investors know very little about the properties in a REIT portfolio. Direct real estate ownership increases the overall transparency of the investments.
The Benefits of Direct Investment
Alternatively, direct real estate investment into assets sponsored by a private real estate company gives investors a stake in one specific property with a specific investment focus. Direct investment allows investors to select the specific property type, the location, and the operator that best suits their investment strategy and objectives. The following are notable attributes of direct investing with a sponsor:
The investor gets to pick and choose which properties to invest in and the dollar amount they wish to invest into a specific asset. Note: You lose discretion when you make direct investments through a fund. You invest once in the fund, and then the fund decides which assets to acquire; you end up with a percentage interest in each asset purchased by the fund, at the fund’s discretion.
If you directly invest in real estate with a sponsor, you own a percentage interest in a specific piece of real estate and the sponsor has a duty to provide a full accounting of the profit and loss from property operations to the investment group on a regular basis.
Lower Fee Structure
Sponsors do a fair amount of work to put together an investment opportunity for investors to participate in. Sponsor fees are generally much lower than REITs and Funds and land somewhere between 5 – 10% of the capital invested.
The investor owns a percentage interest in a tangible asset, not shares in a company. The value of a hard asset does not fluctuate like stocks and is non-correlated to the returns of the broader stock market.
Stronger Average Returns
Investors receive a prorated share of the cash flow generated from operations, as well as the value appreciation that is realized over time by the asset.
CEP Multifamily is a private equity company that provides investors the opportunity to make direct investments in multifamily workforce housing communities in the Pacific Northwest.
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