As a foreign institutional investor, we are pondering two investment options: REIT and acquiring physical properties. Although we have been involved in several real estate acquisition transactions in our country of origin, we learned that REIT is quite popular in the U.S. and would like to give it a try. What are the pros and cons for investing in an REIT versus physical properties?
Answers
REITS are quite popular. Their stock values have recently become competitive once again. REITS are pass-through entities. Whether or not to invest in an REIT depends on a couple of things. First, whether you are seeking control. A public REIT will have to be transparent in its operations; a private REIT less so. Unless you own a controlling
block, your investment will be passive. One benefit of owning less than 5% of an REIT's stock is that you can sell
without incurring a FIRPTA tax. If you plan to own a large number of properties, an REIT is often an excellent ownership structure.
Investors seeking exposure to real estate can look for investment properties to purchase and rent out, or they can buy shares of a REIT. Becoming a landlord offers greater leverage and a better chance of realizing big returns, but it comes with a long list of hassles, such as collecting rent and responding to maintenance issues. REITs provide a much simpler way to invest in real estate and earn consistent income through dividends, but they confer less control and their upside tends to be lower than that of rental properties. The decision is entirely driven to your appetite for investment and having the right sponsors on the ground to overlook the day-to-day operations.
There are pros and cons to investing in real estate through the public markets versus private through individual ownership in real estate. In the marketplace for publicly treaded REITS, for better or worse, the market values the investment every day based upon many factors that affect the capital markets very broadly. In buying an individual asset, the value is not determined every day but only by the real estate marketplace when you are ready to sell it. The cash flow you receive is direct result of you own success in the leasing, management and operation of the property. Public valuations move up and down with the market as a whole and often are disconnected to the value of the underlying real estate the company owns. Today, most REITs are trading at a 20 percent to 30 percent discount to net asset value (what the underlying real estate is worth based on a private sale of the individual real estate assets). The biggest difference is the complete liquidity of the public markets. In a publicly traded REIT, if there is any reason you need to sell or want to exit immediately due to rapid changes in the market, you can sell immediately. In privately held real estate, it would take months to implement a sale, so the immediate liquidity of public REIT stock is a big advantage. In a public REIT, you are investing in a collection of assets, a strategy and a management team. In a private deal, you are investing in one asset and your own implementation of a plan to maximize its value. Neither is necessarily a better choice, but each has clear benefits and drawbacks.