Internally Managed vs. Externally Managed REIT

Real estate investments offer different opportunities, especially REITs. Internally managed REITs have managers who make investment decisions for clients, while externally managed REITs hire third-party management. How you decide between one type of REIT over the other depends on your investment strategy and goals. Understanding the advantages and disadvantages of each will help you figure out what’s best for your portfolio.

A financial advisor can help you create a financial plan for real estate or other investment goals.

What Is A REIT?

A Real Estate Investment Trust (REIT) is a company that owns income-producing properties or the mortgages of income-producing properties. Most REITs specialize in a specific type of property. But some offer a mix of investments within the REIT.

As an investor, you can buy shares of a REIT. Investors can buy shares through the company or as an exchange-traded fund or mutual fund.

As a shareholder, you buy an interest in the REIT’s properties. When the property generates income, you’ll receive a share of the profits in the form of a dividend.

Essentially, REITs are attractive investment vehicles for investors who want to reap the rewards of real estate. But you might not have the time, energy, or risk tolerance to manage individual properties.

Internally Managed REIT

As stated earlier, internally-managed REITs have managers who make investment decisions. With an internal manager, the incentives between the manager and the shareholder can be more closely aligned.

How This Affects Investments

Internal managers often have the responsibility of only one REIT portfolio. With that, they can spend all of their time and attention optimizing the REIT for shareholders.

This laser focus can bring enhanced capital allocation and efficient portfolio management. Ultimately, shareholders could enjoy the rewards with potentially enhanced returns.

Pros and Cons of Internally Managed REITs

Before you invest, here’s a breakdown of the advantages:

Less potential for conflict of interest
Manager only responsible for one portfolio
Added focus

Now, let’s take a look at some disadvantages:

Potentially less experience
Must create own infrastructure

Essentially, you’re trading experience for service. Internally managed REITs are part of a closed circle that is easier for investors to control. This comes at the expense of growth, as internal managers often lack experience and access to broader infrastructure.

Externally Managed REIT

An image of an apartment building, overlaid with the text "Real Estate Investment Trust."

Externally managed REITs hire third-party managers to make investment decisions.When REITs were first formed in the U.S., external management was the default model based on the example set by the private equity industry. Over time, the U.S. market transitioned to a largely internally managed model for REITs. But on a global level, externally managed REITs are still popular.

This style of management puts less pressure on the REIT to set up back-end operations. Instead, the REIT can rely on the systems put in place by the external manager.

How This Affects Investments

Many REITs still choose this option because external managers can bring more experience and analytical capabilities to the table. But the REIT will have to pay for the help of an external manager.

Typically, a fixed percentage of the assets under management represents the management fee. Additionally, there is often an incentive fee that the manager can unlock by hitting pre-determined performance goals.

Pros and Cons of Externally Managed REIT

Let’s take a look at the advantages of internally managed REITs:

Potentially more experience
External manager brings analytical capabilities

And now, let’s compare the disadvantages:

Split time and attention
Potential conflict of interest

Although an external manager may have more experience and resources, their incentives might not align with the shareholders. For example, an external manager might receive a commission or benefit for adding a particular security to an account. Also, an external manager could choose to prioritize growing the asset base over profitable long-term investments.

How REIT Management Impacts Performance

While the choice between internal and external management often comes down to structure and incentives, it can also influence a REIT’s overall performance. Historically, studies have shown that internally managed REITs tend to deliver higher returns over the long term compared to externally managed ones. This is largely because internal managers’ compensation is tied directly to shareholder returns, encouraging decisions that prioritize sustainable profitability.

Externally managed REITs, on the other hand, may be more focused on asset growth since their fees are typically based on assets under management. While this can lead to faster portfolio expansion, it doesn’t always translate to better shareholder returns, especially if growth comes at the expense of efficiency or strategic capital allocation.

Market conditions also play a role. In periods of economic growth, external managers with broad industry experience may be able to identify and execute lucrative deals quickly. Conversely, in downturns, the close alignment between internal managers and shareholders can help avoid overly aggressive strategies that might harm long-term performance.

Ultimately, while past performance isn’t a guarantee of future results, understanding how management incentives influence decision-making can help you choose REITs with structures that align with your investment objectives.

Bottom Line

When selecting between an internally managed and externally managed REIT, the choice may already be made for you. In the U.S., the vast majority of modern REITs are internally managed. Although it’s possible to find externally managed REITs in North America, markets such as Japan and Australia have more of a mix of internally managed and externally managed REITs. Beyond geography, the fundamental difference between both styles of REITs boils down to the incentive alignment of the managers. A financial advisor can provide additional insights into real estate investing and the role it can fill in your portfolio strategy.

Tips for Real Estate Investing

A financial advisor can help you determine which type of REIT best fits into your financial plan. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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