Real estate is an excellent addition to your investment portfolio, but buying a home isn’t the only way to take advantage.
Commercial real estate projects can be particularly profitable, and you don’t need to have the deep pockets of a real estate tycoon to get started.
Real estate investment trusts and private equity real estate are two ways to invest in commercial projects. Typically, REITs are open to anyone, while private equity investing is an option only for high net worth investors.
Before you dip your toe into the world of real estate investing, let me help by explaining both types of investments, the logistics, pros and cons, how to get started, and more. First, let’s get into the nitty-gritty of REITs and then we’ll dish on the rarefied world of private equity.
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Top REIT and Private Equity Real Estate Investment Picks
Fundrise: 0.15% annual advisory fee. Fundrise Pro: $10/mo. paid monthly, or $99/yr. paid annually. Additional fund management fees apply.*
Minimum investment: $50,000. Fees vary by offering.
What Is Commercial Real Estate?
Commercial real estate is property used to generate profit through rental income or capital gains. Commercial properties include retail stores, industrial spaces, hotels, office spaces, multifamily apartment buildings (with five units or more), and others.
While it may seem as if apartment complexes would be residential real estate, they are actually considered commercial because the apartments are leased out to create cash flow. Residential real estate, on the other hand, is limited to buildings with one to four residential units, such as single-family homes, condos, or townhomes.
What Is a Real Estate Investment Trust?
A real estate investment trust (REIT) is a company that pools investors’ money to obtain and manage income-producing properties. Typically, these are high-end commercial properties. The REIT does the dirty work: finding tenants, collecting rent and maintaining the buildings, for example. Investors buy shares of these properties and enjoy the benefits of ownership without the headaches.
To be a REIT, the investment must meet several requirements, such as:
- The REIT must distribute a minimum of 90% of all taxable income earned by the underlying assets held in the trust to shareholders consistently.
- At least 75% of gross income must originate from real estate-related sources, such as rent and interest on mortgages financing real property.
- 95% of gross income must be passive.
- REITs must have a structure similar to mutual funds, whereby the fund pools investments, and they are overseen by a fund manager.
- REITs must be held mainly by shareholders (a minimum of 100 after its first year of operation).
- The IRS must see the REIT as a corporation.
Types of REITs
Investors have three main avenues: equity REITs, mortgage REITs, and hybrid REITs, which is a combination of both.
Most REITs are equity REITs. These give investors access to diverse portfolios of income-producing assets they likely couldn’t afford on their own.
Equity REIT assets include retail, offices, apartments, and more. These investments pay out most of their income through shareholder dividends.
This type of REIT is a strategic choice for long-term investors who want dividend income as well as capital appreciation. Equity REITs contain many assets, which diversifies your portfolio, but all of them are within the same asset class, so they are not fully diversified.
Mortgage REITs (mREITs)
Mortgage REITs (mREITs) provide financing for income-producing real estate by buying or originating mortgages and mortgage-backed securities. These REITs don’t own and lease out real estate, but instead offer loans. They earn income from the interest paid on these investments.
Something investors should remember: Mortgage REITs typically use more leverage and derivatives than equity REITs, making them riskier investments.
A Key Distinction: Public vs. Private REITs
Another way to classify REITs is by looking at the ways you can purchase them: publicly traded REITs, public, non-traded REITs, and private REITs.
Publicly traded REITs are bought and sold on the market, just like stocks. They let all investors—not just accredited and institutional ones—own shares of real estate through the underlying real estate assets. These REITs are registered with the Securities and Exchange Commission (SEC), meaning they are subject to regulations that aim to help protect investors through offering more disclosures and transparency.
Public, Non-Traded REITs (PNLRs)
Public, non-listed REITs (PNLRs), also called public, non-traded REITs, aren’t traded on stock exchanges, but they are still registered with the SEC and so they must make regular SEC disclosures. Investors can buy these REITs from a broker or financial advisor.
One important difference between PNLRs and other public REITs is that they have limited liquidity. To be able to cash out, investors usually must wait for a liquidity event, such as when the non-traded REIT lists its shares on an exchange or liquidates its assets. In some instances, this could take 10 years or more after your investment.
It’s still sometimes possible to partake in share repurchase programs or secondary market transactions, but some of these programs require shares to be redeemed at a discount.
Private REITs, also called private placements, are exempt from SEC registration and their shares aren’t traded on stock exchanges. Don’t be fooled: A private REIT is not the same thing as private equity investing. Remember, REITs must follow the rules listed above, including distributing 90% of their income to investors, while private equity investing doesn’t.
Typically, private REITs can only be sold to institutional or accredited investors (with some exceptions).
These are usually illiquid investments that often have high minimum investment amounts and come with potentially higher risks, but also the possibility for higher rewards.
Pros of Investing in REITs
Income-Producing Real Estate
The dividend payments REITs provide make them a wise option for investors looking for a consistent, passive income stream. Often, REITs have higher dividend yields than traditional stocks.
Diversification / Low Correlation
REITs are an easy way to get exposure to real estate assets, making them an excellent way to diversify your portfolio.
They have a low correlation to the stock market, so they can hedge against inflation and be less volatile.
Governance and Oversight (With Public REITs)
The SEC regulates public REITs. The SEC’s website gives brief facts about public REITs and investor alerts. These investments must be registered and are required to file regular reports with the SEC.
Investors can review a public REIT’s disclosure filings, such as annual and quarterly reports, on the SEC’s EDGAR database.
Long-Term Performance Orientation
REITs—the non-listed kind, in particular—are designed to be long-term investments and, usually, the longer you hold a REIT, the more the value of the underlying assets increases.
Some REITs actively add value to properties to increase your capital gains.
Related: What is the Capital Gains Tax Rate?
Cons of Investing in REITs
Fees and Loads
Some REITs—especially private REITs and public, non-listed REITs—charge high management and transaction fees. These fees might not be obvious but can be hidden in the fine print. Find out if the REIT you’re considering has acquisition or other fees that may cut into shareholders’ payouts.
Lack of Transparency (With Private REITs)
Private REITs aren’t required to have the same level of transparency as REITs that are publicly traded. For instance, there may be undisclosed conflicts of interest.
In addition, investments that aren’t publicly traded don’t have a market price readily available, so it can be challenging to determine the value of a share.
Volatile (If Traded Publicly)
Trends tend to influence REITs. For example, if a REIT focuses on office spaces and then everyone starts working from home (sound familiar?), it falls out of favor and the value falls.
REITs are also affected by the properties’ location. In addition, REITs that are publicly traded can be volatile depending on how the market is performing.
Limited Growth Potential
All REITs have to pay at least 90% of their taxable income to investors as dividend distributions, hampering growth opportunities.
What Is Private Equity Real Estate Investing?
Now that you’re well-versed in REITs, it’s time for something completely different: private equity real estate investing.
Much like REITs, private equity investing seeks to pool money from several investors into real estate assets. However, this type of investing operates under far different tax, legal and dividend rules. For instance:
- Unlike with REITs, private equity real estate investments are never publicly traded.
- Also, unlike REITs, these investments don’t have to pay out a high percentage of their income in dividends. Instead, most returns in the private equity real estate space come from exits made for higher values, and thus on capital gains and carried interest.
- In addition, these investments are only available to accredited investors with significant cash flow from income and/or high-net worth figures. The initial investment required can easily be in the six-figure range.
The types of real estate investments need not focus solely on income-producing properties but can also include properties targeted specifically for their appreciation value, such as in a real estate development opportunity.
Beyond these differences, private equity real estate investment opportunities differ from REITs (for better or worse) in the following ways:
Pros of Private Equity (Non-REIT) Real Estate Investing
Private equity investments are highly tax efficient. Investors benefit from pass-through depreciation, and as these are long-term investments, they don’t have to worry about paying high short-term capital gains taxes. Public REITs are less tax efficient.
While REITs must pay out the vast majority of their profits to investors through dividends, private equity firms have more flexibility. They can decide entirely how to use investment funds, as long as the investors agree to it. Having more available funds can provide more opportunities to acquire potentially lucrative assets.
Fewer restraints from regulatory agencies such as the SEC allow private placement providers to manage their real estate portfolios in ways that might be more efficient or advantageous than registered investments.
Because private placement real estate isn’t held to the whims of stock prices, management can think longer-term, which can result in better decisions and ultimately better performance.
In addition, investors might feel less pressure as well. Because private placement real estate is less liquid, investors can’t just pull out their money whenever they want like they can with publicly traded REITs.
Cons of Private Equity (Non-REIT) Real Estate Investing
Fees and Overhead
Private equity real estate funds often have annual asset management fees of around 2% of the capital invested. These fees help pay for marketing, salaries, deal sources, legal services, research costs, and more.
There may also be a one-time fee when onboarding an investor into a new investment. Sales commissions and upfront offering fees can add up to 10% of the investment. Check the fine print for any additional costs, such as property management or acquisition fees.
Public REITs aren’t as filled with fees, but they often have lower capital appreciation.
Barriers to Access
Like with private REITs, most private real estate placements are available only to accredited and institutional investors. Also, many private placements require sizable buy-ins, so even if non-accredited investors were allowed to participate, many of them would be priced out.
Another access issue with these investments is that once you get into them, it’s tough to get out! Money invested in private placement real estate typically is inaccessible for years.
They Are Opaque
Private placement real estate investments aren’t registered with the SEC, so they’re not required to provide information such as quarterly and annual financial reports.
Opaque financials and lack of access to investment information can make it exceedingly difficult to know what you’re buying. Plus, without visible, dynamic share prices, it’s hard to accurately value your investment.
Choosing Between Investing in REITs or Private Equity Real Estate in the CRE Space
Choosing the better option for your investor capital will depend on your investment goals, time horizon, liquidity needs, net worth and tax situation.
Deciding between these two may also be influenced by your status as an accredited investor or non-accredited investor. REITs are more flexible for investors because they can trade on public exchanges.
Typically, private equity real estate relies on marketing their investment deals only to accredited investors. Neither one is necessarily better than the other. The question becomes, “Which is more suitable for your needs: REITs or private equity real estate?”
Online REITs Option: Fundrise
- Available: Sign up here
- Price: Fundrise: 0.15% annual advisory fee. Fundrise Pro: $10/mo. paid monthly, or $99/yr. paid annually
Fundrise is a popular real estate and alternative asset investing platform that allows you to diversify through its numerous funds. Each fund holds a number of properties and is designed to provide varying levels of risk and income.
Investors have two primary ways to invest in real estate through Fundrise:
The standard Fundrise account is a managed portfolio that allows you to invest for as little as $10. When you open and fund an account, you select an investment strategy, then Fundrise allocates your money to the fund (or funds) that make up that strategy. As time goes on, Fundrise may add new funds to its available selections and allocate your money toward those funds if they fit within your strategy. You can add more money to your account over time, again with a small minimum additional investment of just $10.
All the while, Fundrise’s dashboard will show you how you’re invested and what you’ve earned. If you’ve set up an Investor Goal, Fundrise’s goals tracker will let you know if you’re on the right track—or if not, what to do to make sure you achieve that goal or goals. Fundrise will also provide updates on real estate holdings’ occupancy, market trends, and more.
Investors who want a little more control over their investments might consider Fundrise Pro—a monthly subscription service that allows you to choose your own investment path, and provides you with more data to make the best choices for you.
Unlike with the managed Fundrise account, Fundrise Pro users can allocate however much they’d like to whatever funds they’d like, making direct investments into specific funds. They can also choose between dynamic allocation (investing more or less into certain funds over time to meet your plan’s specifications) or flat allocation (simply investing the same amount of money per your allocation choices). Fundrise also offers access to its proprietary data warehouse, Basis, as well as curated insights from the Wall Street Journal.
Everything else you should know about the Fundrise platform
Fundrise is primarily a commercial real estate investing platform, but it does have other offerings. For instance, it boasts the Innovation Fund, which holds primarily private high-growth tech companies, as well as a private credit investing strategy.
The platform supports several investment account types, including individual, joint, entity, trust, and IRA. You can fund your initial investment via Automated Clearing House (ACH) from a linked checking account, though Fundrise also accepts debit card, credit card, Apple Pay, and Google Pay, as well as wire transfers for additional investments above $25,000. Just note that debit and credit card investments are limited to $1,000 and are only made available to accounts under $1,000.
Fundrise also allows you to set up automatically recurring investments (again, with a $10 minimum), as well as automatic dividend reinvestment—both of which allocate your funds according to your existing investment plan.
You don’t have to be an accredited investor to use Fundrise—it’s open to any U.S. citizen age 18 or older. But accredited investors do enjoy some perks, including being able to invest directly into several funds closed to non-accredited investors, and occasionally, better ability to invest in Fundrise’s eREITs. If you are an accredited investor, once you’ve opened your account, go to Settings → Advanced Options → Accreditation to upload proper documentation.
In addition to Fundrise’s advisory fees and Fundrise Pro’s monthly fees, the funds you invest in also have their own baked-in management costs. Most Fundrise real estate funds charge a 0.85% flat management fee, while the Fundrise Innovation Fund charges 1.85% annually.
Also, Fundrise shares a trait with traditional commercial real estate investing: It can be highly illiquid. Fundrise itself states that “the shares you own are intended to be held long-term.” You can incur a 1% penalty for selling any eREIT and eFund shares held for less than five years, for instance, though the Flagship Fund and Income Fund don’t feature liquidation penalties.
That said, liquidation requests are typically only reviewed on a quarterly basis, which means even if you want out, you’ll be waiting. Also, you can’t pick and choose what you sell—Fundrise’s “first in first out” system means that when you liquidate, the first shares sold will be those you’ve held the longest.
But despite the liquidity issues, commercial real estate remains one of the best alternative investments you can own—and Fundrise helps people easily reap its rewards. Like with owning shares of publicly held real estate, private CRE price returns will often lag a major index like the S&P 500. But the passive income from real estate investing has been nice: Since 2017, Fundrise’s average annual income return of 5.29% dwarfs that of both public real estate investment trusts (REITs, 4.1%) and the S&P 500 (2.0%). That includes a 1.5% total return (price plus dividends) in 2022 compared to double-digit losses for public REITs and the S&P 500.
Visit Fundrise to learn more about this alternative asset class or sign up today.
Private Equity Real Estate Option: First National Realty Partners
First National Realty Partners is one of the fastest-growing real estate private equity firms in the U.S.
The firm carefully vets and acquires premium properties in affluent, expanding locations. They are selective and will only choose one deal out of a thousand meeting their strict criteria.
First National Realty Partners specializes in well-known grocery-anchored commercial real estate.
Their tenants include popular names such as Tesla, Whole Foods, Starbucks, Walmart, and Walgreens. Properties with name recognition tend to be less volatile than smaller businesses.
Investors earn a passive income from quarterly cash distributions starting on Day One. After several years, typically three to seven, they also receive capital appreciation money.
The firm is transparent and gives investors all the information they need to decide if a property deal is a good fit for their risk tolerance and portfolio.
Read more in our First National Realty Partners review.