A real estate investment trust (REIT) is an entity that typically owns, manages and operates a portfolio of income-producing commercial properties.  REITs allow all investors to invest in large-scale, professionally managed companies that own commercial real estate.  The shares of major REITs are traded on major stock exchanges.   REIT shareholders pay taxes on the dividends they receive and any capital gains at the ordinary income tax rate (short-term gain).  Below are Pros and Cons of investing in REITs versus Direct Investment in Apartments.

 

Pros of Investing in a REIT

  1. Ease of access. Investment opportunities in REITs are plentiful because many REITs are publicly traded.
  2. Low buy-in. The investment amount in a REIT can be low (~ $500) and much less than a direct investment in an apartment community (i.e., a private offering).
  3. Because major REITs are publicly traded, the buying and selling of REIT investments can be immediate and at any time – a “highly liquid” investment.
  4. Available to All Investors. Any person can invest in a major REIT.  This investor does not have to be sophisticated or accredited per the Securities and Exchange Commission.
  5. Immediate diversification. A REIT investment is in a group of assets rather than a single asset, so there is more diversity than investing in a single asset.

 

Cons of Investing in a REIT

  1. Lower risk-adjusted returns. The risk-adjusted returns are typically lower those achieved in private investments of single-purpose real estate assets.
  2. Not Tax Efficient. Investors do not receive any tax advantages that could be obtained through the tax shield of depreciation of real estate assets.  REITs pay a dividend that is taxed as ordinary income.
  3. Arms-Length Investment. Investors will not know the exact assets that are owned by the REIT. So, although the investments are in tangible cash-flow producing assets, passive investors will not have the following:
    1. direct access to management
    2. ongoing communication from the asset managers about how the assets are performing
    3. an understanding of the business plan(s) for each asset owned within the REIT and status of the execution of those business plans

 

Pros of Private Ownership in a Multifamily Asset

  1. Better Understanding of Risk and Reward. The passive investor can gain a better understanding of the potential risks and potential returns of the investment through review of the Private Placement Memorandum (PPM) and business plan and conversations with the management team. The investment offering and business plan will illustrate the sponsor team, property manager, market and submarket analysis, property details, business plan, and proforma financials.
  2. Tax Efficient. The investment is in a single-purpose entity (typically an LLC) that owns the asset.  This entity is taxed as a partnership (rather than corporation) so this is a disregarded entity for tax purposes.  The taxation (or lack thereof) flows directly to the individual investors (K-1).  The assets are aggressively depreciated over the 3 to 7-year investment hold period using such strategies as bonus depreciation and cost segregation.  This large amount of depreciation each year typically offsets the cash flow received during the hold period and even at refinance or sale.  Profits at refinance or sale are beyond the one-year hold period so the gains are recognized as long-term gains and not taxed at the higher ordinary income tax rate.  Therefore, the result is tax free income received by the passive investor during and at the end of the investment hold period.
  3. Direct Ownership. As a limited partner (LP) in the LLC that owns the asset, you as a passive investor are an owner.  With this direct ownership, you have access to the general partners (GP) and will receive monthly updates on how the property is performing that includes photos and financial information.  You can also contact one of the GPs to get any questions that you may have answered.
  4. Better Returns than REITs. Green Bison invests in opportunities that typically have a minimum 8% average annual returns during the hold period (excluding the profit from sale) and a minimum 15% average annual returns during the hold period (including the profit from sale).  Therefore, investing $100,000 would return a total of $175,000 over a 5-year period ($75,000 profit).  These risk-adjusted returns are typically higher than those achieved by REITs.  REITs have returned about 25% over the past five years. Therefore, investing $100,000 would return a total of $125,000 over a 5-year period ($25,000 profit).

 

Cons of Private Ownership in a Multifamily Asset

  1. Requires More Homework. A prudent investor will do his homework/due diligence before investing in a private offering.  This process requires more thought and research of the risks and rewards than what would be required in buying a publicly traded REIT.  Publicly traded stocks have tons of information readily available through tools such as Google Finance or Yahoo Finance.
  2. Requires Investor to be Accredited. Not just any investor can invest in a private real estate offering.  To protect the investor in a private offering of an investment opportunity, the Securities and Exchange Commission requires the investor to be accredited.  Depending on the private offering’s exemption filing to Regulation D, sophisticated investors may participate.  Visit the “Connect” page of the website for a link to definitions of accredited and sophisticated investors. Many real estate syndication offerings follow Rule 506(b) which means that the sponsor team must have a relationship with the investor before the offering is made and limit the passive investor group to no more than 35 sophisticated (non-accredited) investors.
  3. Limited Liquidity. The business plans for syndicated real estate investments typically are 3 to 7 years with many being in the 5-year time horizon.  Therefore, as a passive investor, you should be prepared to have your initial investment tied up for 5 years.  It is not impossible to get your money returned prior to completing the business plan, but this is strongly discouraged.  The Operating Agreement of the Single-Purpose LLC will explain the terms and conditions in the event a passive investor needed to pull his investment out of the deal.
  4. High Minimum Investment Amount. The minimum investment amount is typically $50,000 and can be higher.