What Is a Real Estate Operating Company (REOC)?
The term real estate operating company (REOC) refers to a company that engages in real estate investments and whose shares are traded on a public exchange. These publicly-traded companies own and actively invest in properties—generally commercial real estate. Unlike real estate investment trusts (REITs), REOCs reinvest the money they earn back into their business and are subject to higher corporate taxes than REITs.
- A real estate operating company engages in real estate investments and trades on a public exchange.
- REOCs can reinvest their earnings back into the business rather than distribute them to unitholders the same way REITs are compelled to do.
- REOCs have the potential for greater growth prospects than REITs but they might not generate as much immediate income.
How Real Estate Operating Companies (REOCs) Work
Investors have a number of options if they wish to diversify their holdings and add real estate to their portfolios. Purchasing real property is one option, but that can come at a big cost and immense risk. Investors who buy properties—residential and/or commercial real estate—must be able to bear the financial burden of purchasing and maintaining properties in addition to the risks and uncertainties that come with the housing market.
Real estate operating companies are an alternative to owning real property. These companies can shield investors from some of the risks that come with holding physical real estate. REOCs are companies that purchase and actively invest in different types of real estate. The majority of their holdings are commercial properties such as retail stores, hotels, office buildings, shopping malls, and multifamily homes. Many REOCs also invest in and manage properties. For instance, a company may sell or lease out units of a multifamily home or office building to different people but still maintain and earn money from common spaces such as parking lots and lobbies.
Shares in REOCs are traded on exchanges just like any other publicly-traded company. Investors can purchase shares through their broker-dealer or another financial professional. Although they eliminate the risk of holding physical property, REOCs are subject to certain market risks including interest rate risk, housing market risks, liquidity risk, and credit risk.
REOCs are structured in a way that allows them to reinvest their earnings back into the company rather than distribute them to shareholders. As such, they can expand their holdings by purchasing new properties or putting money back into existing holdings to improve them. They may also use earnings to buy new properties for the express purpose to sell them back at a later date. Being able to reinvest their earnings means REOCs get no favorable tax treatment, so they pay higher taxes than REITs.
Real estate operating companies pay federal taxes because they are not required to distribute their earnings to shareholders.
Real Estate Operating Company (REOC) vs. REIT
Although they both invest in real estate holdings, there are functional and strategic differences between REOCs and REITs. REITs own and operate properties that generate income through rents or leases. These may be residential dwellings, hotels, and even infrastructure properties such as pipelines and cell phone towers. Investors can choose to buy shares in three different types of REITs—equity REITs, mortgage REITs, and hybrid REITs.
In order to qualify as a REIT, companies must meet certain requirements. These include—among others—investing a minimum of 75% of their assets in real estate and distributing at least 90% of their earnings as distributions to unitholders. In exchange, REITs get favorable tax treatment. Corporate taxes for REITs are far lower than those imposed on REOCs because they are exempt from federal taxation.
REITs tend to invest and purchase properties that limit the amount of risk associated with certain commercial properties because of the special tax status they enjoy. Their investment strategies tend to be for the long-term. This means REITs don't purchase investment properties in order to sell them in the future the same way some REOCs do.