June 25, 2019

Real Estate Investment Trusts (REITs) are a diversified pool of assets that distribute quarterly dividends and have the potential to realize long-term capital appreciation making them appealing for an investment portfolio. But like most vehicles with high returns, they still carry additional risks that need to be considered. For some, investments in private real estate funds continue to be a good alternative investment strategy; here is why. 


As investments into private real estate continue to hit record highs identifying the key characteristics that differentiate a private real estate fund from a REIT are fundamental to making sound investment decisions.

When you invest in private equity real estate funds, you are in control when to allocate your capital, what strategy to utilize, and which geographic location best suits your investment goals. The deployment of capital into a private real estate fund allows investors the opportunity to experience the tangibility aspect of owning a piece of real property or an asset unique to the real estate investment space. Put differently, a private equity fund manager allocates your funds into an investment that has a value based on real cash flows, not pie-in-the-sky future assumptions.

Additionally, the growth of a publicly traded REIT is lower than the potential of common stock. The main reason is that REITs are required to distribute 90% of their profits in the form of dividends each year, leaving only 10% of their annual profits to drive growth. This characteristic significantly inhibits a REITs ability to reinvest profits and forces the investment managers to look for additional investment if they want to expand and diversify their portfolio. Additional investment typically involves either increasing debt loads or issuing more equity. Issuing more equity to raise capital can dilute the existing ownership shares in the security while increasing the debt load can lead to added risks associated with higher leverage.


A major benefit to investing in a private real estate fund is that an investor does not need to worry about the short-term fluctuations in the value of their investment being reflected in the public markets. Instead, REITs trade like equities on a public exchange and their share prices are more susceptible to high levels of volatility on a frequent basis rather than reflecting the true value of the underlying real estate.

Even though REITs’ long-term returns are generally positive and are comparable to that of an opportunistic focused real estate fund, their short-term performance could be volatile or even negative, especially during a crisis. For example, the Dow Jones Wilshire REIT Index WILREIT, +0.12% lost half its value in just two years, falling 17.6% in 2007 and another 39.2% in 2008. REITs could also produce negative absolute returns when interest rates are rising. When rates are low, investors typically move out of safer assets to seek income in other areas of the market. Conversely, when rates are high or during uncertain times, investors often gravitate back to fixed-income investments.

When you invest in ground-up real estate development, you become an owner of the property and can choose to do as you please at your sole discretion. You are in control to buy whatever you want, wherever you want, whenever you want. However, with a REIT, you’re a passive investor. You have just a choice to invest in professionally managed companies that own many types of commercial real estate ranging from office and apartment buildings, to warehouses, hospitals, shopping centers, hotels, storage facilities, and even data centers. They buy the property, manage it, and do the accounting for you. Your sole role is to be ensured that small or big slices of your properties are managed properly.


Assessing tax implications is a crucial component of investing in any asset class, and this consideration is no different with commercial or investment properties. IRS Section 1031 or a “1031 Exchange”, is a widely used tool in private real estate investment funds which allows a taxpayer to avoid paying capital gains taxes by exchanging real property for other “like-kind” real property ultimately giving investors the ability to manage their overall tax burden. Conversely, REIT dividend distributions are taxed as ordinary income at a much higher rate. Although a REIT can execute a 1031 exchange at the entity level, individual REIT shares are considered personal property and do not qualify for a 1031 exchange.

In conclusion, Investments in private real estate funds provide more flexibility and protect you from the movement of the public market. While there are still risks like with any other asset class. Be sure to research, analyze metrics, check reports, and find professionals with in-depth local market knowledge, extensive expertise, and strong relationships with developers, sales teams, and government institutions to ensure that risks are mitigated to the best of your ability, and your investment dollars are protected.

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