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Private Equity Real Estate Funds vs. REITs

Commercial real estate investors who are not interested in direct ownership of property may instead choose to invest in private equity real estate funds or real estate investment trusts (REITs). The two options are similar in that they offer investors the option to invest in large-scale, income-producing commercial real estate, such as retail property, office buildings, multifamily housing and warehouses without directly purchasing property. However, they differ in multiple ways, including where the money is invested, how much direct involvement an investor has over its management, the tax implications of the investment and the time commitment for capital invested.

Below is a brief explanation of both types of investment opportunity and the unique attributes of each.

Private Equity Real Estate Funds

Private equity real estate funds are pooled investment vehicles that consist of equity and debt investments in the real estate market. The funds are contributed to by multiple investors and are typically focused on long-term returns with a time horizon of six to 10 years.

  • Not publicly traded and therefore not subject to SEC regulations and requirements
  • Only available to accredited investors
  • Funds are less liquid and generally require that capital be invested in properties over a term of at least six years
  • Performance is based on the performance of the real estate market funds are invested in and not the stock market
  • Easier to invest in different types of properties for further portfolio diversification
  • Capital is managed by a team of advisors
  • Fund operates tax-free; when funds are distributed to investors, gains and losses are taxed at the individual level at either long-term capital gains rates or short-term capital gains rates. (For related reading, see: How to Invest In Private Equity Real Estate.)

Real Estate Investment Trusts (REITs)

REITs are companies that own or finance income-producing real estate. REITs behave more like mutual funds; they allow people to invest in real estate by purchasing REITs securities, such as stock. REITs also can go beyond investing in buildings, as 10% of REIT investments are in mortgages, while American Tower, one of 2017’s “must-buy” REITs, is composed entirely of communication towers.

  • Subject to SEC regulations and requirements.
  • Publicly available option for all investors if it’s publicly traded.
  • Funds are fairly liquid if publicly traded and can be bought and sold on the market as frequently as desired.
  • Share prices are subject to the volatility of the market; therefore, REITs often perform more like stock than like real estate.
  • Portfolios usually consist of the same property types, meaning an investor who desires to diversify commercial real estate property investments will need to purchase stock from multiple REITs.
  • Capital is managed by the individual or company investing—or by a private advisor hired by the investor to assist in management.
  • Special tax rules apply; in general, REITs typically pay out at least 90% of income to shareholders in order to secure exemption from taxation. From there, dividend payments made to shareholders are taxed as ordinary income, unless certain extenuating circumstances apply.

Which Option Is Right for You?

Ultimately, the decision on whether to invest in private equity real estate funds or REITs depends on a variety of factors, the first and foremost being whether or not an investor qualifies to invest in private equity funds, as these are traditionally exclusive to high net worth, accredited investors. Individuals who do not qualify who wish to invest indirectly in income-producing commercial real estate property are limited to investing in REITs. But for accredited investors, the choice is a more complicated one. (For related reading, see: Should I Get Into Private Equity Real Estate?)

Investors who have a more "set it and forget it" mentality might be drawn toward private equity real estate funds because the funds are managed by a team of advisors who handle the decision-making process regarding which investment properties have the highest potential for return long-term. Private equity real estate funds are also attractive to individuals who want their investment to perform in response to what the real estate market is doing rather than the more volatile public markets.

Conversely, investors with a need for quick access to their capital will appreciate the liquidity of publicly traded REITs securities. The focused nature of REITs (which have portfolios comprised of one type of commercial real estate property) might also be a draw for investors who desire to invest in certain types of real estate property at the exclusion of others, or who do not want the added complication of further diversifying their commercial real estate investment.

When considering which type of real estate investment to add to your commercial or personal portfolio, take into account the aforementioned characteristics of each and make the choice that most closely aligns with your financial goals and overall investment strategy.

(For more from this author, see: Using a Self-Directed IRA to Invest in Real Estate.)