Real Estate Investment Trusts (REITs) are companies that invest in residential, commercial and/or industrial real estate properties. Their primary goal is to generate income from rental properties. Benefiting from the price appreciation of real estate properties is the secondary goal.
According to NAREIT, REITs own nearly $3 trillion in gross assets with publicly traded REITs constituting $2 trillion and the remainder in private REITs. Per SEC regulations, a publicly traded REIT must distribute at least 90% of its income to shareholders as dividends, making them highly defensive and great additions to an income portfolio.
Despite the 90% rule, some REITs have poor payout ratios. Click here to find out why.
A publicly traded REIT such as Boston Properties (BXP) or Realty Income Corp. (O) is usually the first exposure investors have to real estate investing (outside of buying a house for themselves). But investors may want a more direct approach to real estate investing by choosing a private REIT instead.
A private REIT is generally structured as a limited partnership with the general partners making investment decisions and managing the business while the limited partners are the investors providing the capital to invest in other properties. While they are essentially the same kind of business as the publicly traded ones, they follow different rules that may make them a more attractive option for some investors.
While many investors are familiar with REITs as an asset class, knowledge of private REITs and how they work is limited. Below, we will explore what a private REIT can offer investors and how it differs from publicly traded ones.
Be sure to read this article to familiarize yourself with various terminologies associated with REITs.
Getting to Know Private REITs
Investing in a private REIT is essentially becoming a part-owner of a business. The limited partnership aspect of private REITs gives investors a more direct approach to the real estate market without being subjected as heavily to stock market fluctuations.
Private REITs aren’t always accessible to any investor. Most have eligibility criteria such as a minimal initial capital investment that can range from $10,000 to more than $100,000 along with a net worth requirement of at least $1 million (excluding private residences) and/or income of $200,000 annually for the previous two years in order to qualify them as an accredited investor.
Private REITs are exempt from registration with the SEC per Regulation D of the Securities Act of 1933, and as such, require investors to do a little more due diligence before investing. These companies aren’t required to report financial information, which gives them more flexibility with investment options but also presents a larger risk since there is limited accountability when compared to publicly traded REITs.
Because private REITs are limited partnerships, they don’t offer the kind of liquidity that publicly traded REITs do through stock offerings. Most private placements come with a lock-out period that can range from anywhere up to two years, but even following that period redemptions may not be possible outside of extenuating circumstances. Until a corporate action is taken to sell a property, investors may not see a return or have the ability to liquidate their holdings.
While publicly traded REITs are subjected to stock market valuations, private REITs are largely immune to the same forces, making private REITs less volatile. For income investors, lower volatility and more reliable income generation are key considerations. However, investors should note that volatility can be used in a beneficial manner as well for quicker gains, which means that private REITs are preferable for long-term investments only.
Publicly traded REITs can suffer from stock valuations where the price of the asset deviates from the intrinsic value of its real estate holdings. Private REITs, however, don’t have that consideration and track the value of the real estate market more accurately. The underlying value of the properties owned by the REIT are the only basis for determining its value.
Use the Dividend Screener to find high-quality dividend stocks, including REITs. You can even screen stocks with DARS ratings above a certain threshold.
So, When Should You Pick a Private REIT Instead of a Public REIT?
There are a number of reasons why an investor might choose one type of REIT over the other, but the first barrier of having to qualify as an accredited investor means that not everyone who wants to invest in a private REIT has the ability to do so. But simply qualifying for a private REIT doesn’t mean that it’s the better choice. There are a number of other factors that need to be taken into account.
If investors want to track the real estate market without having to deal with stock valuations, private REITs are ideal. Long-term price appreciation of real estate holdings makes private REITs a more accurate gauge of the market than publicly traded ones whose stock price is influenced by factors that are not within an investor’s control.
One of the other considerations for investors is liquidity. While a public REIT that’s sold like a stock on the broader exchanges can be bought or sold with relative ease, a private REIT is a limited partnership business. That means that capital invested in the private REIT needs to be non-essential since a redemption can be challenging – if allowed at all.
Be sure to visit our complete recommended list of the Best Dividend Stocks.
The Bottom Line
REITs are great dividend-generating investments regardless of whether you invest in a publicly traded company or take on a private enterprise via a limited partnership.
If you want to gain exposure to real estate without having to deal with the volatility of stock valuation in addition to real estate valuations, a private REIT satisfies that criteria. It also offers higher dividend yields on average, making it a great addition to an income-driven portfolio. If investing for the long term and being a limited partner in a business are appealing to you, then private REITs are the best option.
Be sure to visit our News section for regular updates around dividend investing.
