In my life in Investor Relations, I get asked daily: “Is a Fund the same as a REIT?”. Let’s break it down.
What is a REIT, technically speaking?
A REIT is a specific tax structure created in 1960 and has very specific guidelines under the Internal Revenue Code (IRC). A REIT must invest at least 75% of total assets in real estate, cash or US Treasuries. A REIT must derive at least 75% of its gross income from rents, interest on mortgages of real property, or real estate sales. A REIT must pay a minimum of 90% of taxable income in the form of shareholder dividends.
And that brings us to our first big difference. But I will continue with the definitions first.
A REIT must be an entity that’s taxable as a corporation (number 2 difference). A REIT must be managed by a board of directors or trustees. A REIT must have at least 100 shareholders after its first year of existence. And a REIT must have no more than 50% of its shares held by five or fewer individuals.
So, now that we know the technical rules of a REIT, what types of REITs are there?
The most common REIT that people think of is the publicly traded REIT. These are the most visible and any retail investor with a Robinhood app can buy shares. But not all REITs are publicly traded. There are Non-traded REITs. These are companies that publicly report financials and are available to all investors, through licensed Broker Dealers, but do not trade their shares on any exchange. And lastly, there are Private REITs. These are commonly private equity funds with individual or institutional accredited investors, with exempt offerings through a Private Placement.
What is a Private Real Estate Fund?
A Private Real Estate Fund is a private offering, or placement, and issuance of securities. The proceeds of which will be used to invest directly in real estate. Frequently, these funds will buy multiple assets and commingle the funds. There is no specific structure of a Private Real Estate Fund, but they are most commonly structured as a Limited Partnership.
How is a REIT the same as a Private Real Estate Fund?
Most commonly, both will own a diverse portfolio of income producing property. Technically, either could own a single asset, i.e. the Empire State Building is a single asset REIT structure, but portfolios are more common.
How is a REIT different than a Private Real Estate Fund?
The biggest difference for many investors is the tax treatment. Your tax form from a REIT investment will be a 1099-DIV. Your tax form from a Private Real Estate Fund will commonly be a K-1, assuming it is structured as a Limited Partnership.
What is the benefit of a REIT?
While this isn’t a comparison to a Private Real Estate Fund, the single biggest benefit of REITs is the mitigation of the corporate double taxation. Any corporation has to pay corporate taxes first, distribute dividends from after-tax earnings and the shareholders have to pay taxes on the dividends, creating the double taxation. Under the IRC for REITs, if all requirements are met, there is no taxation at the corporate level, only on the shareholders, thereby creating a favorable tax treatment.
What is the benefit of a Private Real Estate Fund?
For many investors, it is the tax treatment through the K-1. Losses can be passed through directly to the Limited Partners on a K-1, which is not available in a REIT and 1099.
Please note: I intentionally kept this blog high level. There are significant differences between a publicly traded REIT and a Private Real Estate Fund in regards to liquidity, access for investors, transparency of reporting, etc. The intent is to outline that a REIT can take many operational forms, but will always have the same tax treatment, which varies significantly from the tax treatment of a Limited Partnership.
About the author:
Evan is the Investor Relations Consultant for Ashcroft Capital. As such, he spends his days working with investors to better understand their investment goals and background. With over 13 years in real estate, he has seen all sides of real estate from acquisitions, to capital raising on the equity and debt side, to operations, and actively invests himself. Please feel free to connect with Evan on Linkedin and message him through LinkedIn with any questions.