Investing in Private REITs vs. Public REITs

Real estate investment trusts (REITs) are a popular choice for investors wanting to add real estate exposure to their portfolios without the hassle of owning physical properties. These entities pool money from investors to buy and manage real estate and then return a portion of the profits to their shareholders. However, it is important to distinguish private REITs from public REITs, As each option comes with its own set of advantages and disadvantages. Understanding these differences is crucial to making an informed investment choice.

As you compare private REITs vs. public REITs, consider speaking with a financial advisor about which option might be more appropriate for you.

What Is a Public REIT?

Public REITs are traded on national stock exchanges, making them widely accessible to individual investors. They fall under the regulatory oversight of the Securities and Exchange Commission (SEC), which requires regular disclosure of detailed financial information. This regulation bolsters the security of investing in public REITs, reducing some of their risk.

According to Nareit, an organization that represents REITs and real estate companies, there are over 225 publicly traded REITs in the U.S. that have a combined market capitalization of more than $1 trillion. These REITs are registered with the SEC and trade on one of the major stock exchanges, usually the New York Stock Exchange (NYSE).

Examples of public REITs include the Simon Property Group, which owns dining, shopping and entertainment properties around the world, as well as Public Storage, which acquires and manages self-storage facilities.

Pros of Investing in a Public REIT

Public REITs are traded on stock exchanges, providing investors with liquidity that traditional real estate investments and private REITs lack. You can buy and sell REIT shares with ease, allowing you to react swiftly to changing market conditions.

REITs are also required by law to distribute at least 90% of their taxable income to shareholders in the form of dividends. This means investors can potentially enjoy a steady stream of income that is typically higher than what many other stocks offer. REITs can provide a reliable source of passive income, making it especially appealing for retirees and income-focused investors.

Cons of Investing in a Public REIT

Like stocks, public REITs can be subject to market volatility, causing short-term losses. Investors need to be aware of the fluctuations public REITs can experience and understand how market conditions and economic circumstances can impact their dividends.

There is also the matter of taxation, as REITs are taxed differently than stocks. REIT dividends are taxed as ordinary income, resulting in a higher tax rate for some investors compared to long-term capital gains. In addition to REIT taxes, investors should check for any management fees and expenses that can reduce overall returns.

Do not forget to watch interest rates. Rising interest rates can also negatively impact REITs, as they may increase borrowing costs and reduce the appeal of dividend yields.

What Is a Private REIT?

REITs invest in a range of properties, including apartment complexes like this one.

Private REITs are investment entities not listed on national securities exchanges. They are generally offered to accredited and institutional investors through private placements. Examples include Broadstone Net Lease, Inc., and Starwood Capital Group’s Starwood REIT, both of which have left significant imprints on the real estate sector.

However, because private REITs are not as tightly regulated, they bring increased risk. While they have the potential to offer higher returns, it is important to note that these returns are never guaranteed.

It is also important to note the distinction between private REITs and non-traded REITs. Neither is traded on a stock exchange, but the latter is still open to the public and falls under the purview of the SEC.

Pros of Investing in a Private REIT

Potential advantages of investing in private REITs include the possibility of higher returns and greater stability.

Since private REITs aren’t subject to the same regulatory and reporting requirements as public REITs, they can have more flexibility in their investment strategies. Their ability to invest in non-traditional, less competitive properties can create more opportunities when capitalizing on market inefficiencies. However, remember these higher returns are not guaranteed, only possible.

There are also unique tax advantages associated with investing in private REITs. Since they are structured as pass-through entities, REITs do not pay federal corporate income tax. Instead, income and deductions flow to the individual investors. This can potentially result in lower overall tax liability.

Cons of Investing in a Private REIT

Private REITs have some drawbacks.

They typically have longer holding periods, tying up your money for an extended period. Additionally, they may lack the liquidity of publicly traded REITs, making it more challenging to sell your investment if needed.

Moreover, private REITs are generally riskier investments compared to their publicly traded counterparts. They may lack the same level of transparency, making it harder for investors to assess the REIT’s underlying assets and overall performance.

Keep in mind that private REITs are only available to accredited and institutional investors, so they are not designed for the average retail investor hoping to invest with little money.

Private REITs also typically require higher minimum investments, ranging up to $25,000.

Types of Investments in Public and Private REITs

Both private and public REITs can make large-scale investments in a myriad of real estate properties. For instance, they may manage extensive portfolios of office buildings, shopping centers, apartment complexes or warehouses. They can also invest in niche sectors, including data centers, cell towers and timberlands, providing ample opportunities for portfolio diversification with their unique risks and rewards.

When to Invest in a Private vs. Public REIT

Choosing between a private REIT vs. public REIT largely depends on your financial goals, although public REITs are the more popular choice for individual investors. They are suitable for those who want to buy and sell REIT shares like stocks, although private REITs often offer higher dividend yields.

On the other hand, private REITs may be better suited for affluent investors who do not mind a longer commitment. This type of REIT often requires a larger initial investment but can be ideal for those seeking a long-term passive approach to real estate investment.

Types of REITs

There are several types of public and private REITs, each with its own unique characteristics and complexities.

Equity REITs

Equity REITs, the most prevalent REIT category, specialize in acquiring and owning real estate assets that regularly generate income. They encompass a wide range of properties, including residential complexes, shopping centers and commercial space, as well as office buildings and entertainment venues.

Investors in equity REITs reap rewards in the form of dividends derived from the rental income these properties produce.

Mortgage REITs

Mortgage REITs, as the name implies, focus their investments on mortgages and mortgage-backed securities. Their income streams come from interest collected on the loans they hold or from the acquisition of mortgage-backed securities. While mortgage REITs can offer potentially higher yields, they are susceptible to fluctuations in interest rates and credit risk.

Two key examples are Annaly Capital Management and Starwood Property Trust within the mortgage REIT sector.

Hybrid REITs

Hybrid REITs blend attributes of both equity and mortgage REITs. As a result, a hybrid REIT may own physical properties and invest in debt. This diversification can help mitigate some of the associated risks.

Specialized REITs

Some REITs focus on specific sectors, such as healthcare, data centers or infrastructure. These specialized REITs allow investors to target niche markets while potentially benefiting from industry-specific trends.

Liquidity and Exit Strategies

One of the biggest differences between a private REIT vs. public REIT is how easily investors can access their money. Public REITs offer daily liquidity, meaning you can buy or sell shares on a stock exchange at any time during market hours, just like a typical stock. This flexibility allows investors to quickly respond to market changes or adjust their portfolio when needed.

Private REITs, on the other hand, are far less liquid. Because they aren’t traded on public exchanges, there’s no active market for buying or selling shares.

Investors in private REITs may face lock-up periods lasting several years. During this time, their capital is effectively inaccessible. Even after the lock-up period, redemption opportunities may be limited to quarterly or annual windows, with requests subject to funds availability.

Additionally, early redemptions from a private REIT can incur penalties or be executed at a discount, reducing your overall return. For instance, a private REIT might impose a sliding fee structure where redeeming shares within the first year cost 5% and gradually decrease over time.

To avoid surprises, carefully review the REIT’s offering documents or prospectus. Pay particular attention to these factors:

Lock-up periods
Redemption frequency and conditions
Penalty structures
Procedures for submitting withdrawal requests

Investors considering private REITs should plan to hold the investment long-term and avoid using funds that might be needed for near-term expenses. For those who value quick access to their capital, a public REIT may offer greater peace of mind.

Bottom Line

A homebuyer looks at an online listing for a property that's owned by a real estate investment trust.

Understanding the intricate differences between a private REITvs. public REIT is paramount when contemplating indirect real estate investing. While they both expose investors to real estate investments, public REITs are traded like stocks on public exchanges. Private REITs, on the other hand, are only open to accredited and institutional investors through private placements. Be sure to weigh the unique advantages and disadvantages of all types of REITs to determine if they have a place in your portfolio.

Consider asking a financial advisor about the best real estate investments for your portfolio based on your existing capital, time horizon and risk tolerance.

REIT Investment Tips

Did you know there are three types of REITs: mortgage REITs, equity REITs and hybrid REITs. Here’s a closer look at these three variations and how to invest in them.

A financial advisor can help you select investments that align with your financial goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.