Private REITs: A Guide to Investing

Private REITs offer a unique investment opportunity for accredited investors, allowing them to invest in a diversified portfolio of properties without directly managing them.

Investors can choose from a wide range of property types, including commercial, residential, and industrial properties.

A minimum investment of $1 million is typically required to invest in a private REIT, making it accessible to high net worth individuals.

Private REITs often provide a steady stream of income through rental properties, and investors can also benefit from potential long-term capital appreciation.

A REIT, or Real Estate Investment Trust, is a tax-advantaged investment vehicle created in 1960 to buy and hold real estate, generating returns through rental income and property appreciation.

REITs are required to return 90 percent of their earnings to investors in the form of dividends, which means they often have lower growth rates than other investment vehicles. This is because they're only allowed to reinvest 10 percent of their earnings in growth.

To qualify as a REIT, a company must be managed by a board of directors or trustees and have at least 100 shareholders after its first year.

Non-traded REITs are sold by brokers and advisors, offering a more stable investment option with lower volatility and less correlation to the stock market. This means the value of a non-traded REIT is based on the valuation of its assets, giving investors a clearer understanding of the investment's true value.

Non-traded REITs are available to the public, subject to the same SEC reporting and regulations as publicly listed REITs. However, they come with a trade-off: liquidity risk, as shares can be difficult to sell and often require a minimum hold period.

Publicly traded REITs, on the other hand, are listed on national securities exchanges and tend to be more liquid. Private REITs, by contrast, are sold to institutional investors and aren't listed on the national securities exchange or registered with the SEC, making them more illiquid.

Private REITs offer a flexible structure, allowing for ownership by parallel fund vehicles, making it an attractive option for fund structuring.

Traditionally, REITs were required to be listed on a stock exchange, but the 2022 amendments have removed this requirement where at least 70% of the REIT's ordinary share capital is held by institutional investors.

This flexibility has made private REITs a popular choice, especially for global institutional investors who are familiar with this structure from other markets.

Using fund vehicles that meet the genuine diversity of ownership test provides an attractive option for fund structuring, and in our experience, a number of fund managers are exploring using a partnership structure to admit investors, with a private REIT held directly beneath.

Private REITs can be used in a fund structure, offering a more flexible approach to ownership and investment.

Publicly Traded REITs offer a similar process to investing in other exchange-traded public securities, with shares bought and sold on exchanges like NYSE and NASDAQ.

Investing in publicly traded REITs is highly liquid, with standard trading fees, making it accessible to anyone. There is no accreditation requirement, allowing anyone to invest.

Valuation of publicly traded REITs is determined by the market and changes daily, making them highly correlated with the stock market and subject to market volatility.

Managers of traded REITs may focus more on producing short-term earnings rather than long-term growth due to market pressures. The trust must be registered with and is regulated by the SEC, requiring regular disclosures, including quarterly and annual audited financial reports.

Private REITs are not required to register with the SEC and are not subject to the same reporting requirements as publicly traded REITs. They are only available to accredited investors and have high investment minimums.

Private REITs are highly illiquid, and investors should be aware of the risks associated with illiquid real estate investments. These risks include the potential for long-term holding periods and the lack of a secondary market.

Unlike non-traded REITs, private REITs are not correlated with the stock market, and their value is based on an appraisal of assets. This can make them a more stable investment option, but also less liquid.

Private REITs are often sold by broker-dealers and may feature high fees. These fees can include acquisition fees, asset management fees, and other costs associated with the formation of the fund.

Private REITs are usually valued based on an appraisal of assets, rather than market sentiment. This means that managers can focus on long-term investment goals without the risk of upsetting investors who may watch for daily price changes in the market.

Private REITs are not subject to the same level of transparency as publicly traded REITs, and investors may have limited access to information about the fund's management strategy, performance, and fee structure.

Estate Mortgage Conduits, also known as Real Estate Mortgage Investment Conduits (REMICs), are a type of business entity or trust that pools mortgage loans and issues mortgage-backed securities.

They can be formed as any type of entity, but in practice, they're typically formed as trusts. REMICs are pass-through entities, meaning income is taxed only at the investor level.

A REMIC's assets must consist of mortgages secured by interests in real estate, and these mortgages are usually transferred to the REMIC on the date it's formed or within three months of formation.

Unlike mortgage REITs, REMICs are largely inactive after funding, as they must be fully funded not long after formation.

If you're considering investing in private REITs, you're likely looking for the benefits and advantages that come with this type of investment.

Investing in private REITs can provide a passive investment in real estate with more direct ownership of the actual properties, allowing you to benefit from the illiquidity premium and potentially higher ROI over time.

A private REIT firm takes the burden of management off your plate, freeing up your time and expertise to focus on other areas of your life.

These firms specialize in acquiring, developing, and selling properties, and their incentives are aligned with your success, meaning they'll work hard to maximize returns on your investment.

Investing in private equity real estate offers several advantages.

One major benefit is that it allows for more direct ownership of the actual properties, giving investors a sense of control and involvement in the investment.

A private equity real estate firm takes the burden of management off the investor's plate, freeing up time and resources for other pursuits.

This can be especially beneficial for high net-worth investors with a long-term time horizon, as they can rely on the firm's expertise to navigate the investment cycle.

Investors in private equity real estate demand an "illiquidity premium", a higher rate of return to compensate for the lack of flexibility and risk of locking up funds for a longer period.

Incentivized for success, PERE firms are motivated to find the best investment opportunities. They specialize in acquiring, developing, operating, and selling properties, which means they have a vested interest in maximizing returns.

Their in-house expertise allows them to optimize properties by investing in improvements to management, operations, design, and architecture. This expertise also helps them find the right buyer at the right time to maximize returns.

Incentives are aligned for private equity to not only raise money but also perform. This means they're motivated to actively seek out favorable investment opportunities based on factors like cash flow, location, and job growth.

By structuring their funds as limited partnerships or limited liability companies, PERE firms can reward their general partners for their work and the risk they assume. This structure allows the general partner to receive a percentage of profits significantly greater than their ownership percentage, typically ranging from about 15% to 20%.

The general partner's profits interest, also known as a "promoted interest" or "carried interest", is a key motivator for them to perform well. It's a percentage of the profits that's significantly greater than their ownership percentage, which means they have a strong incentive to maximize returns.

Tax benefits can be a significant advantage of PERE investments.

PERE investments may present tax benefits to the investor.

These benefits can lead to increased cash flow, as investors can retain more of their earnings.

Private REITs are designed to be leaner and more efficient, with a smaller team and lower overhead costs. This allows them to focus more on the success of the asset and generating returns for investors.

Less overhead also means less front-end fees, as Private REITs often make more of their money on the back end after certain performance metrics are hit. This can be a more attractive option for investors who want to see returns without breaking the bank.

Technology is also playing a key role in streamlining the investment process, creating efficiencies and saving time and money. The use of electronic signatures and straight-through processing technology is making it easier for advisors and sponsors to manage the investment process.

PERE funds are designed to be large enough to take advantage of real estate investment opportunities but small enough not to require an army of employees and brokers to manage.

Less overhead means a stronger focus on the success of the asset and generating returns for investors. This approach helps PERE funds make more of their money on the back end after certain performance metrics are hit rather than the front-end fees associated with REITs.

Technology solutions have also created efficiencies in the investment process. Straight-through processing technology allows advisors and sponsors to save time and money by creating efficiencies in a traditionally error-prone and paper-laden investment process.

Traditionally, REITs were required to be admitted to trading on a recognised stock exchange, but the 2022 amendments have removed this requirement where at least 70% of the REIT's ordinary share capital is held by institutional investors.

The 70% test considers other commonly used fund structures, such as authorised unit trusts, or English limited partnerships, that meet a genuine diversity of ownership (GDO) test as institutional investors.

Real estate consultant John Forbes, who was consulted by HMRC on the GDO amendments, has said that the rules on this have recently been made even more flexible, allowing ownership by parallel fund vehicles too.

Using fund vehicles that meet the GDO test provides an attractive option for fund structuring.

In our experience, a number of fund managers are exploring using a partnership structure to admit investors, with a private REIT held directly beneath.

This type of structuring has been commonly used elsewhere, for example in the US, for many years now, so is well understood by global institutional investors.

Non-traded REITs raised $33.2 billion in 2022, down slightly from 2021's market peak of $36.5 billion raised.

Rising interest rates led to a significant slowdown in non-traded REIT fundraising in 2023, with only $10 billion raised.

High up-front fees are still a common issue in the non-traded REIT sector, with fees of 10 to 15 percent of the gross investment amount being common.

This means that only 85 to 90 percent of an investor's commitment is put to work, and the remaining 10 to 15 percent goes towards fees.

Investor statements still report the REIT value at par before fees, which can be misleading.

General securities members are required to provide accurate per share estimated values on customer account statements.

Transparency surrounding the underlying value of the real estate held in a customer's account has helped shed light on fee drag.

Sponsors like Blackstone, Griffin, and Cantor Fitzgerald are engineering REIT products that embrace greater transparency around value, fees, and performance.

These new products eliminate acquisition, disposition, financing, and/or development fees from the overall fee structure.

By reporting the Net Asset Value (NAV) instead of the Net Investment Amount (NIA), sponsors have better aligned interests between sponsors, advisors, and investors.

Sponsors continue to be paid management fees and a performance incentive over an annual return hurdle.

Investors benefit from more frequent reporting, increased competition between product sponsors, and a greater portion of their investment "in the ground".

More sponsors are following suit and creating non-traded NAV REITs with multiple share classes that make the asset class more accessible.