Investing Strategy - September 21, 2024

REITs vs Private Real Estate: Why I Choose Private Equity Real Estate

September 21, 2024

Brian Davis
By Brian Davis

REITs vs. private real estate — which one’s better? When most investors think of passive real estate investing, publicly traded real estate investment trusts (REITs) are often the first thing to come to mind. An REIT is a security that trades like a stock on the major exchanges and owns or finances income-producing real estate.

Although REITs offer plenty of advantages, I’ve chosen not to invest in them. Instead, I opt for other passive real estate investments, which come in many varieties and are ultimately a better fit for my needs. Each category comes with its own pros and cons, which we’ll discuss in depth in this article.

REITs vs Private Real Estate Definition

Both (public) REITs and private real estate (via real estate crowdfunding and other platforms, like EquityMultiple) are accessible by individual investors. While they may target similar underlying assets, these security types tend to have different performance characteristics.

REITs vs Private Real Estate Equity

Just like stocks and ETFs, shares of REITs trade on public stock exchanges. You can typically invest in a single share for about $10-30.

In order for their securities to qualify as REITs, investment companies must meet certain criteria. They must distribute at least 90% of their profits in the form of dividends, and must hold at least 75% of their assets in real estate. Likewise, they must earn at least 75% of their income from real estate. These assets and income can include debts secured by real estate.

Like all publicly-traded investments, you can buy and sell shares of REITs anytime you want. However, that liquidity comes with a cost — price volatility. (More on that shortly.)

REITs vs real estate private equity

REITs are big!

Private equity, by contrast, encompasses a broader group of investments — any investment in a private company that owns real estate-related assets. 

These include real estate syndications, which are essentially group real estate investments in which an investor buys fractional ownership of a larger property such as an apartment complex. You earn cash flow, appreciation, and tax benefits, but you don’t take on the headaches of owning a property directly. 

Other passive real estate investing options include private equity funds, crowdfunded real estate equity or debt, and fractional ownership in single-family rentals. 

What Is Real Estate Private Equity?

Real estate private equity is a form of real estate investing that entails owning a portion of a real estate asset that is transacted on private markets. In other words, real estate private equity is illiquid and performance is a function of management skill and quality to a very high degree.

The Problem with REITs

Public REITs offer an easy way to invest, with full liquidity and sometimes high dividend yields over 10%

All of those upsides come with corresponding downsides. The ease of investing means that you have no competitive advantage — you only get the market returns of the moment. The liquidity of an REIT means that it has enormous volatility, as with other stocks. And the high dividend yields — a byproduct of the 90% profit sharing requirement — leave less room for price growth.

But none of these represent the biggest problem with REITs. To my mind, the notion of “diversifying your portfolio to include real estate” is defeated by the correlation between REITs and the stock market at large. 

After all, if your “real estate investments” depreciate right alongside your stock investments, do they have the best diversification benefits? 

A study conducted over several decades by Morningstar discovered a correlation of 0.59 between U.S. REITs and the total U.S. stock market. That’s on par with other sectors of the economy, such as consumer staples (0.57), telecommunications (0.62), and energy (0.64). 

In a previous analysis based on NCREIF data (the preeminent source of performance data for private real estate), NAREIT data (for REITs) and public market data sources from Bloomberg, private real estate had a far lower correlation with public assets than public REITs between 2000 and 2019.

cross asset correlation - public vs private real estate and correlation with the S&P

In 2022, the S&P 500 delivered a total return of -18.1%, while U.S. REITs returned -25.1%. Meanwhile, home values jumped up 10.49% in 2022, even as 64% of sellers claimed it was a worse market for selling. 

Other Passive Real Estate Options

I've chosen not to invest in REITs because they provide little diversification benefit for my purposes, and I don’t buy properties directly because it's too labor-intensive.

Instead, I enter into private real estate syndications and funds. These have plenty of potential for diversification, and may be a path to earning passive income.

Real Estate Syndications & Funds

In a classic real estate syndication investment, a professional investor — known as the sponsor — finds a deal, and then raises money from passive investors to help pay for it.

Let's take an example: Sarah the Syndicator finds an apartment complex for $10 million. She takes out a loan to cover $7 million of that, puts in $500,000 of her own cash, and then raises the other $2.5 million from investors like you and me. We effectively become fractional owners in this group real estate investment.

Platforms like EquityMultiple facilitate these types of syndicated investments. Our asset management team vets investments every month, and anyone who wants to participate can do so starting at just $5,000. Altogether, we invest enough to meet the minimum investment requirement (typically $50,000 - $100,000).

In a nutshell, a real estate syndication is an investment partnership where a group of investors pool their resources into a single real estate investment. It typically involves general partners (GPs) and limited partners (LPs). The key players are:

  • Real estate syndicators/sponsors/general partners (GPs): Strategize investments, secure financing from passive investors, and have more liability and effort in exchange for a larger share of returns.
  • Limited partners (LPs): Less liable than GPs but entitled to a smaller portion of cash returns.
  • Passive individual investors: Supply capital and work with GPs/LPs to understand investment health, with lower liability and returns.
  • Managing entities: Act as liaisons, offering investment opportunities, asset management, and guidance.
  • Joint venture partners: Separate entities only liable for their specific role within the partnership.

Alternatively, Sarah might buy multiple properties as part of a real estate fund. Maybe she knows all the properties she will buy with the raised capital, or perhaps she raises the money first and then finds the best properties to acquire (a blind fund). 

Either way, you can participate in these pooled investments passively as a "silent partner." You don’t have to exert yourself on finding deals, renovate properties, or managing tenants. You can just wire in the funds and sit back to collect distributions.

EquityMultiple offers both of these types of real estate investments, from investments in individual properties to funds that encompass several different properties.

Real Estate Crowdfunding: Equity

In an equity crowdfunding investment, you buy into the ownership of one or more properties.

The term “crowdfunding” has come to include many different types of investments. Most crowdfunding platforms don't describe themselves that way, but if we are being technical, any platform that files its offerings under the SEC’s Reg CF counts as crowdfunding. (Keep in mind that some platforms allow non-accredited investors to participate while others don’t. If you don’t qualify as an accredited investor, screen for that first when researching crowdfunding investments.)

Some of these platforms offer pooled investment funds that own many different properties. Others let you buy fractional ownership in a single-family rental property. Both of these are common examples of equity crowdfunding investments. 

In addition to equity, many crowdfunding platforms also offer debt secured by property as an alternative form of investment. 

Real Estate Crowdfunding: Debt

Rather than owning a small piece of a larger property, you could also own debt secured against real estate (or, if you want to be a little fancier about it, "real estate private credit.")

That could mean investing in a single loan secured against one property. Or it could mean investing in a pool of loans secured against many properties. 

On top of offering real estate private equity opportunities, EquityMultiple offers real estate debt investments, such as its Ascent Income Fund, predicated on real estate private credit. (The Alpine Note is another fixed-income, collateralized offering from EquityMultiple.) 

When you invest, double check whether you’re investing in senior debt or debt further down the capital stack. There are different risk-return profiles for every instrument in the stack.

Here's another question we get a lot: what is the difference between real estate private equity and private equity investments, as pertains to investing in pre-IPO startups? In other words, real estate crowdfunding vs. equity crowdfunding. Both are private-market alternative investments that are recently available to individual accredited investors on a fractionalized basis. That said, there are some key differences:

Real Estate Private EquityPrivate Equity / Pre-IPO Startups
Investments in tangible, often cash-flowing assets
Investments in the future prospects of a private company, often with no in-place revenue flows
Can offer counter-cyclical investment thesis
Often highly dependent on capital markets and broader economic conditions
Opportunity for attractive upside
Opportunity for "moonshot" upside, but correspondingly very high levels of risk. 
Opportunity to diversify across different CRE sectors (industrial, multifamily, self-storage, etc.)
Opportunity to diversify across growth sectors, e.g. proptech, biomedical, consumer products, etc.  

Many self-directed investors may choose to invest in both real estate private equity and equity crowdfunding (investments in pre-IPO companies) as part of their alternative investment portfolio. However, both carry a high degree of upside potential and idiosyncratic risk. Most investors will opt to counterbalance with public assets, private credit, and other assets with more downside protection.

What are the Differences Between Debt and Equity?

Debt investments provide a predetermined, fixed rate of return and offer the highest level of security to investors. On the other hand, equity investments do not have a cap on the potential returns an investor can earn if the investment performs exceptionally well. However, this uncapped upside potential with equity also comes with higher risk compared to debt investments. Be sure to weigh the pluses and minuses of each approach.

Various forms of passive real estate investing are available to investors, including real estate private equity and private REITs.

AspectREITsPrivate Real Estate Investments
Investment VehiclePublicly traded companies that own/operate income-producing real estatePrivate equity funds, syndicates, or individual property investments
LiquidityHighly liquid, traded on public stock exchangesIlliquid, investors cannot easily sell shares/ownership
DiversificationHigh correlation with public equities (e.g. stocks)Low correlation with public equities
LeverageModerate use of debt, regulated limitsFunds can use higher leverage at their discretion
Income StreamDividends from rental incomePeriodic distributions from rental income
Appreciation PotentialShare price appreciation reflects asset value growthDirect participation in property appreciation
ManagementExternally managed by REIT companySponsor/manager oversees investments
TaxesDividends taxed as ordinary incomePreferential tax treatment for real estate investments

How Should You Invest in Real Estate?

You've heard me out. I personally invest in real estate syndications, equity crowdfunding, and secured debt crowdfunding. I no longer invest in rental properties directly, or in public REITs.

But your investing goals and needs are different from mine, and I shouldn't sway you. You might tolerate the high correlation between stocks and REITs if their liquidity makes them more attractive to you than illiquid group real estate investments (and other private real estate investments offered by crowdfunding platforms).

If you don’t know much about real estate investing but want to diversify your portfolio, take a look at the most established crowdfunding platforms. EquityMultiple stands as one of the leading firms in this category, distinguished by its extensive due diligence and high-touch investor relations. There are also a number of platforms for non-accredited investors, which you can read about in my rundown of real estate crowdfunding platforms.

If you’re intrigued by private equity real estate investing, do some research on real estate syndications. Consider this the next level up in difficulty. 

Only consider direct property investing if you want to take it on like a side hustle. It involves a great deal of self-education and labor, and you can’t skimp on either one if you hope to consistently earn the same kinds of returns you can earn passively. In exchange for the intensive work of managing property, however, you will get full control over your investment.

Only you know your own investing priorities. Start small if you must — but get started all the same.

For more on REITs, please consult this article.

For more on real estate private equity, please consult this article.

 

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Real Estate Private Equity — FAQs

Q: What is real estate private equity? A: Real estate private equity involves pooling capital from investors to acquire, develop, and manage real estate properties, aiming to generate returns through income, appreciation, or both.

Q: Who can invest in real estate private equity? A: REPE investments are typically available to high-net-worth individuals, institutions, and accredited investors due to their substantial capital requirements and risk profile.

Q: How does real estate private equity differ from REITs? A: Unlike REITs, which are publicly traded and offer liquidity, real estate private equity funds are private, require larger capital commitments, and have longer investment horizons.

Q: What are the potential returns on REPE investments? A: While returns can vary widely based on the fund's strategy and market conditions, REPE investments often target returns that outpace those of traditional investment vehicles. The specific return profile depends on the fund's investment strategy, with more aggressive strategies typically targeting higher returns.

Q: How can I start investing in real estate private equity? A: Accredited investors interested in REPE can start by researching and connecting with platforms like EquityMultiple, which offers access to pre-vetted commercial real estate opportunities across various strategies and geographies.

By understanding the intricacies of real estate private equity and leveraging platforms like EquityMultiple, accredited investors can unlock the potential of real estate investments, diversifying their portfolios and aiming for substantial returns. This guide has aimed to provide a deeper understanding of REPE, highlighting its structure, opportunities for diversification, and the potential for significant returns, all while emphasizing the importance of thorough market analysis, strategic investment planning, and diligent due diligence.

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Brian Davis
Brian Davis
Brian Davis is a real estate investor, personal finance writer, and cofounder of SparkRental with over two decades in the real estate and finance industries. He owns fractional shares in over 1,800 units, and regularly contributes as a real estate and personal finance expert for Inman, BiggerPockets, R.E.tipster and more. Along with his wife and daughter, he spends most of the year abroad living by his own rules. He loves hiking, cooking, pairing wine with said cooking, scuba diving, and occasionally surfing (badly). Most of all, he loves showing others how they too can create their ideal lives through real estate investing and lifestyle design.

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