721 UPREITs: Just an off-ramp for your 1031 exchanges – or a wealth-preserving strategy in its own right?

Among tax shields for wealthy individuals and families, 1031 exchanges hold a time-honored status. By reinvesting the proceeds of a real estate sale into a like-kind property, you can delay paying capital gains taxes on it for a very long time – theoretically, forever.

At some point, though, you might want to actually realize that capital gain – trade in that growing portfolio for a robust cash stream. That’s where the Section 721 Umbrella Partnership REIT comes into play. While 1031 exchanges allow deferral of capital gains, at some point, investors may want to transition to a more liquid, diversified structure. An UPREIT enables you to convert your property into operating partnership units, which we’ll explain in a moment. This switchover not only monetizes your holdings, but it puts an end to the constant paperwork and reporting requirements of the 1031 exchange game.

But is that all there is to UPREITs? Are they just the last link in your chain of 1031 exchanges once you choose to retire from actively managing your own real estate holdings? Or are there other use cases for them? We believe there are.

To find those use cases, though, let’s first review how UPREITs work, what favorable tax treatment they convey and who stands to benefit most from employing them.

How UPREITs work

REITs have been around since 1961, but it wasn’t until 1992 that OP units were enabled by federal statute. That would be the previously referenced Section 721 of the applicable part of the Internal Revenue Code: “No gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.”

OP units are ownership interests in the operating partnership of a REIT, which function similarly to shares but have different liquidity and tax characteristics. In other words, they are proportional ownership interest in the operating partnership, as opposed to the REIT itself.

UPREITs differ from traditional REITs in two ways, according to REIT guide author Stephanie Krewson-Kelly. An UPREIT is a REIT that holds its properties through an operating partnership (OP) structure. This allows property owners to contribute real estate tax-deferred in exchange for OP units, instead of selling for cash.(The OPs are called “umbrella partnerships” by regulators, thus the UP in UPREIT.) Second – and this is the key point of distinction for many investors UPREITs can acquire property by exchanging OP units as well as through cash or common stock.

These structures look like this:

In this picture, you’d be one of the affiliates off to the right – those who sold their real estate holdings to the UPREIT. OP units are the usual currency of exchange because of their tax advantages; such a transaction is considered tax-deferred under Section 721, so the property owner need not immediately pay capital gains taxes on the property transfer.  Still, you might elect to take a portion in cash or other consideration. Consult a tax professional to understand how these tax implications may apply to your situation

To become an affiliate, you must contribute your property. As with any real estate transaction, it’s a negotiation and the usual advice applies. This starts with knowing the value of the property you hold via market analysis and appraisal. But that’s the easy part; you’ve probably done it a hundred times. But you were doing it for cash, and OP units are most certainly not cash.

First of all, OP units are far less liquid, and it’s your job to figure out just how much less liquid and discount their value accordingly. If the UPREIT has a mandatory lockup period, that’s a need-to-know. Kiplinger’s reports that such is the norm, and these periods typically run from 12 to 24 months.

And don’t assume a listing on a major stock exchange is irrevocable.

“Because the [UP]REIT could be delisted from the exchange on which [its] Shares are traded, there might be little or no liquidity for the … Shares issuable upon exchange of redeemed OP Units,” cautions a panel of partners from the century-old law firm Vinson & Elkins.

The V&E partners further cautioned that liquidity could be reduced even further “due to insider trading prohibitions or the short swing profits rule of Section 16 of the Securities Exchange Act of 1934”. In a nutshell, that means if you end up with 10% or more of the UPREIT’s equity or accede to the board or top management team, you can’t reverse your exposure to the company for six months, according to the National Association of Stock Plan Professionals.

You should also be aware of when OP units can be – or must be – converted into publicly traded REIT shares, and what the formula for that conversion would be; typically it’s 1:1, but you should nail that down. This lack of liquidity, though, is a feature rather than a bug. It’s what makes the IRS receptive to the idea of deferring the capital gains; if you could easily trade OP units, the tax authorities would be more likely to consider it a cash-equivalent deal and require you to realize your gain. The longer you hold OPs as opposed to REIT shares, the longer your investment remains tax-shielded. Again, you should consult a tax professional to understand how all this may apply to your unique situation.

Second, while you hope and expect them to appreciate relative to cash, there’s no guarantee that they in fact will. You’ll need to quantify the degree of risk you’re taking because your participation with this UPREIT will likely outlive you and be passed down to your inheritors.

Nor are OP units entirely analogous to shares of stock. While they are economically similar, they don’t automatically convey any voting rights. In this way, they’re more like limited partnerships than like other REITs. If you’re accustomed to having a say in the governance of your property, you might want to bear this in mind as you negotiate.

There’s a twist on the UPREIT you should be aware of. Someone with a love of either wordplay or quantum physics named it the DownREIT. These were typically a legacy REIT that wanted to convert to an UPREIT structure but found it too costly or complicated. Instead, it would become a DownREIT by acquiring the portfolio of one specific affiliate and managing it separately from the rest of its assets. This allows these more established REITs to compete with UPREITs as they strive to acquire new properties.

A DownREIT, then, is a facility through which a REIT assists real estate owners in retaining control of their current real estate. According to academic site WSO, investors can negotiate for the REIT to agree to a standstill or lockout agreement once it’s time to sell the contributed assets.

UPREIT benefits

The immediate benefit of an UPREIT is the steady cash flow. Rather than the boom and bust of the real estate market, you now get to kick back and get your distributions, typically on a quarterly or monthly basis. That’s actually a benefit of UPREITs over 1031 exchanges, which you have to keep juggling to defer taxes on your capital gains.

Speaking of tax deferral, that is of course the next important benefit of an UPREIT. Once you transfer your holdings to the OP,  the arrangement protects your capital gains as long as you hold OP units rather than REIT shares. This is much the same arrangement as a 1031 exchange, through which you reinvest the proceeds of the sale of your assets and buy fractional equity shares of a Delaware statutory trust, which owns and operates its own properties. As always, a tax professional is best positioned to help you understand how the implications for your own situation.

DSTs are also frequently used in tandem with UPREITs, again according to Kiplinger’s, particularly some DSTs allow investors to transition into an UPREIT through a 721 exchange, but the timing varies. Many REITs enforce a multi-year lock-in period before allowing this conversion. Essentially, the DST-to-UPREIT path boils down to a three-step process:

  1. The investor enters a DST via 1031 exchange.
  2. The DST provides an option to transition the assets into an UPREIT.
  3. The investor accepts OP units in the UPREIT, completing the 721 exchange.

This path ensures that the like-kind rules are scrupulously followed. It also enables real estate investors with a modest portfolio to rinse-and-repeat until they have accumulated enough to make a 721 exchange worthwhile; that’s typically somewhere around $30 million in assets.

One main difference between an UPREIT and a DST is that the UPREIT tends to offer much greater diversification. You are essentially commingling your holdings with those of other investors in similar situations. This of course minimizes the risk of the overall portfolio. DSTs tend to be the ownership and management structure of a single property or tight cluster of properties.

Another difference is liquidity. Again, the only reason why either of these options is tax-advantaged is because they are by nature illiquid. That said, at least OPs can be converted into UPREIT shares, which are readily tradable. Ideally, you wouldn’t want to make that conversion during your lifetime but, once your legacy has been passed forward, each beneficiary can decide individually whether or when to cash out.

Estate planning is very much part of an UPREIT’s appeal. To start with, OPs or UPREIT shares are a lot more fungible than property deeds. Further, your heirs’ tax basis for the assets would be their fair market value on the day of your passing rather than their value on the day you entered into the 721 exchange. Assuming the assets appreciated, that’s a tax advantage you can leave to your loved ones – the degree of which is best left to a tax professional to calculate.

And let’s not forget the reason for any investment: returns. Even before the tax shielding, an UPREIT ought to present superior financial benefits to your standalone real estate investment. You should also consider fees and commissions; UPREITs tend to be more efficient than DSTs, but there’s no guarantee. If the vehicle you’re contemplating has not historically outperformed both before and after tax and fee considerations, that might be a signal to choose a different one.

Potential downsides

You can’t outrun the IRS forever, just until you die. When you or your inheritors convert your OPs into UPREIT shares, you must pay taxes on those capital gains.

You might incur other taxation. First, your distributions will be taxed as regular income. While you might not be crazy about the idea of paying 20% of your windfall upon realizing your capital gain, let’s remember that the distributions will probably be levied at a higher rate. You won’t experience the same sticker shock because the income will be spread out over years, but we shouldn’t fool ourselves.

There may be a way out, though. OP or UPREIT distributions may be classified as a return of capital, deferring immediate taxes. However, this reduces the tax basis of OP units, potentially increasing capital gains taxes when they are eventually sold.

If your net worth is greater than around $14 million – and, if you’re looking at UPREITs, it probably is – you face the spectre of the estate tax. Unless you’re survived by an inheriting spouse, your estate will get hit with a 40% marginal tax rate. Suddenly, the 20% rate of the capital gains tax doesn’t look so usurious, but you should get the opinion of a tax professional when making such comparisons relative to your own portfolio.

As we discussed before, you lose direct control over your property when you enter into a 721 exchange, but that is not, strictly speaking, an economic imposition. More critical is the market risk. You went into real estate in the first place because it has such a strong tendency to appreciate in value, but nothing is for certain. There is always market risk. Not only could you find yourself selling into a recessionary environment, the underlying properties could become less valuable. Even if the land itself constantly rises in value, the buildings occupying it are constantly depreciating in both accounting and real-world terms. There’s no guarantee that the OP units you traded your property for will mature into even more valuable UPREIT shares.

UPREITs are, of course, subject to the same stresses as any other business, so you should pay particular attention to its debt. A high debt-to-equity ratio, above-average exposure to variable interest rates and a tendency to borrow money to pay distributions are all red flags.

Let’s also not lose sight of the cost of doing business.

Finally, there’s “finally”. The UPREIT is the end of the road for deferring capital gains. There are no more like-kind exchanges to be made once you pull the trigger on a 721 and transfer your holdings directly into an UPREIT. If you’re closer to the beginning or middle of your real estate career, this probably isn’t for you.

Should you be looking at an UPREIT?

So who is it for?

Before we answer that question, let’s be clear on one thing: You shouldn’t do anything based on one thought leadership article you saw on the internet. That advice goes well beyond investing for capital gains deferral. No matter your personal finance goals, the only firm advice we’re prepared to give you is to talk to someone who gives firm advice on personal finance goals for a living.

That said, the profile of an investor who should consider a 721 exchange is generally a seasoned real estate investor who is seeking to spend less time at work and more time at leisure. This person might also be of an age at which estate planning is becoming an increasingly important consideration – someone who wants to make life a little easier for the inheritors. The intention is that each heir should receive liquid assets rather than real property so they can each monetize their inheritance at their own convenience.

It practically goes without saying that this investor has a high net worth and is seeking a tax-efficient exit strategy for appreciated properties.

While 721 exchange volume and value comparisons are difficult to track over time – nobody has a duty to report them – a wide array of sources suggests that the pace is quickening rather than slowing. That’s impressive, especially considering the bang UPREITs started out with.

“A total of nine equity REITs had held initial public offerings (IPOs) in the United States in 1991 and 1992, the beginning stages of the Modern REIT Era. Yet, in 1993 alone, 44 equity REITs went public,” according to the industry group Nareit. “What changed in that one particular year? [OP units] and the expansion of the UPREIT structure came into vogue.”

The Nareit article goes on to say that the 721 exchange was invented in response to the extraordinarily tight lending restrictions that followed in the wake of the late 1980s’ savings-and-loan crisis.

“I was told by one banker that if you brought in cash as collateral equal to the amount you wanted to borrow, you still couldn’t get a loan … The scrutiny on real estate exposure was that strong,” one Taubman Centers executive told Nareit.

At the close

Still, that doesn’t explain the rapid drumbeat of new 721 exchanges today. We need to look at the broader economy to understand this better.

So perhaps the real reason why we’re seeing such a surge of interest in 721 exchanges today is that they’re necessary – not just for the affiliates, but for the general partnerships themselves.

Given current economic conditions, REITs may increasingly turn to private property owners as sources of capital, making UPREIT structures an attractive option for both investors and sponsors. They should not expect to do it out of a sense of public virtue. Rather, the firms that operate UPREITs – and DSTs for that matter – may benefit from seeing these private affiliates as dependable, flexible sources of the capital which they need to expand and modernize their portfolios.

And these affiliates, as wellsprings of resources needed to fuel the real estate market through what could be some narrow straits, may present strategic opportunities for both investors and REIT sponsors.

Sources:

https://www.govinfo.gov/content/pkg/USCODE-2011-title26/html/USCODE-2011-title26-subtitleA-chap1-subchapK-partII.htm

https://bin.ssec.wisc.edu/ABI/kaba/REIT/ch6.pdf

https://www.kiplinger.com/real-estate/deferring-taxes-with-a-721-exchange-pros-and-cons

https://media.velaw.com/wp-content/uploads/2019/11/28180433/c14d6fbb-276d-49e3-889b-16930b4e1945.pdf

https://www.govinfo.gov/content/pkg/COMPS-1885/pdf/COMPS-1885.pdf

https://www.naspp.com/blog/section-16(b)-the-short-swing-profit-rule

https://www.wallstreetoasis.com/resources/skills/finance/upreit-vs-downreit

https://www.irs.gov/faqs/interest-dividends-other-types-of-income/gifts-inheritances/gifts-inheritances

https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax

https://www.reit.com/news/reit-magazine/november-december-2013/open-business

Investing in alternative investments may be speculative, illiquid, and not suitable for all clients. They are intended for investors who meet certain criteria and are willing and able to bear the unique economic risks of the investment. Investors should consider whether such investments are suitable in the light of their individual financial situation.

Market Outlook 2023: Navigating Economic Uncertainty

Market Outlook 2023: Navigating Uncertainty in Geopolitical and Macro-Economic Headwinds

As we enter 2023, the market outlook is facing a multitude of uncertainties as the geopolitical and macroeconomic headwinds that plagued us in 2022 still persist. The global economy did not see the strength that many had hoped for, as unprecedented inflation swept through economies not seen in almost two generations.

The Fed and other central banks tightened monetary policy, widening credit spreads, and causing sell-offs across equity markets. Political strife in several areas across the globe did not help the situation either, and to top it off, we saw the biggest war in Europe since World War II with the Russian invasion of Ukraine.

Where are the markets now, and what can we expect for the future? While we cannot predict the future, it is reasonable to anticipate that many of the challenges we faced last year will continue to affect the market outlook for the foreseeable future. The Ukraine War, in particular, will likely have a significant impact on investor confidence as it continues to unfold. The direction of domestic and global inflation is another area of uncertainty.

While U.S. inflation seems to be slowing down, history has shown that we could still be returning to an accelerating pace of rising prices. This makes it difficult to predict how inflation will affect economic growth in a monetary tightening environment. Therefore, we should expect continued turbulence across asset classes, strategies, and markets.

Despite the challenges, there were some managers and strategies that successfully navigated the 2022 environment and generated strong returns for investors. These include global macro, equity market neutral, multi-strategy on the hedge fund side, and private credit, LBO, and some venture on the private markets side. These managers and strategies may be well-positioned to capitalize on global uncertainty if these trends continue in 2023.

As we face more uncertainties from a political, social, and economic point of view, this may be the start of a golden age for alternative assets. Alternative assets may provide a way for investors to diversify their portfolios and potentially generate strong returns in the face of continued market volatility.

2022 Year in Review

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To better understand the market outlook for 2023, we must first reflect on what happened in 2022. While there was a lot of volatility in prices, the year started and ended with almost identical rates of inflation (7.04% on Dec 31, 2021; and 7.11% on Nov 30, 2022). Despite this consistency, inflation had a significant impact on the markets, with low growth and rising rates causing credit spreads to widen and equities to sell off.

Alternative Assets Outperformed in 2022 Amidst Volatility and Uncertainty

In the world of finance, the year 2022 was marked by an unprecedented degree of volatility and uncertainty. As the Federal Reserve started to tighten monetary policy, raising the Federal Funds rate by 75 bps at its July meeting, the immediate impact on growth was apparent, with two quarters of contraction in the middle of the year and a significant slowdown in employment.

Meanwhile, consumer confidence and spending, as well as the housing market, remained robust, while business confidence, as measured by the ISM Purchasing Managers Index, only recently turned negative in Nov of 2022.

In public asset markets, nearly all USD-denominated risk assets experienced a year-over-year selloff, including the S&P 500, Dow Jones Industrial Average, U.S. Treasuries, Barclays AGG, and cryptocurrencies, as well as some energy, agricultural, and industrial commodities prices. As a recent article in Vox put it, "the economy just doesn't make sense anymore."

However, despite this backdrop of turbulence, some alternative assets saw strong performance throughout 2022. Hedge funds, in particular, outperformed the S&P and AGG in 2022, with nearly every HFRI index delivering positive returns. Strategies that traditionally capitalize on high volatility and market uncertainty, such as Global Macro, saw particularly strong returns, with the HFRI Total Macro Index returning +9% over the last year, and the HFRI Equity Market Neutral Index seeing returns of nearly 2%.

On the private market side, while overall performance with private equity remained muted, private credit experienced enormous growth, driven by a handful of factors. As rates rose and risk appetite dropped, the primary market for syndicated and leveraged loans nearly evaporated, with a transition from banks being the primary source of funding to the direct lender ecosystem within private credit.

At the same time, investors' allocations to private credit have gone to a smaller pool of funds, as the private credit markets have started to mature, with investors finding themselves more selective when choosing a manager as the importance of diversification, track record, experience, and independent service providers rises to the forefront of investors' minds as recession fears loom.

Market Outlook for 2023: Insights for Investors

As the world enters 2023, uncertainty looms over the global economy. While it is challenging to predict the market outlook for this year, the events of 2022 offer insights into the factors that could affect the markets. In this article, we will look at some of the key issues that investors should consider before making investment decisions.

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Geopolitical Front: Tensions in Key Regions

Geopolitical factors such as war, civil unrest, and political tensions are likely to continue to affect markets in 2023. The ongoing war in Ukraine and tensions in the Taiwan Strait and the South China Sea may have a significant impact on the public’s perception of the global economy. Additionally, the sociopolitical unrest that Iran experienced in the last several months may escalate, further affecting the markets.

The Impact of COVID-19

COVID-19 remains a critical factor affecting the global economy, and it is likely to continue to do so in 2023. As China shifts from its zero-COVID approach to a more open economy, we can expect some degree of social strife as society adjusts.

The resurgence in purchasing power experienced by China after the initial lull from COVID-19 in late 2020 could lead to supply chain bottlenecks that could spill over to other parts of the world. At the same time, the recent rise in cases and deaths in China could result in a reactionary shutdown, affecting its economy and industrial capacity.

Macro-economic Front: Inflation and GDP

Forecasting how inflation and GDP will perform is challenging. However, investors and analysts anticipate a slowdown, possibly even a mild recession in the US, as the Fed Reserve continues to restrict monetary policy. If inflation were to plummet faster than expected, rate hikes might decelerate, pause, or even reverse in 2023, as the effects of 2022’s rate hikes permeate throughout the economy.

Where Can Investors Turn This Year?

Given the high level of uncertainty in the global economy and political sphere, investors may be well placed to consider alternative investments. Global macro, a strategy where hedge fund managers nimbly play across marketplaces, countries, and asset classes, to capitalize on market dislocations, may be worth considering.

In a slow growth environment, equity market neutral may be effective at avoiding overall equity market beta. Private credit may also see outperformance, given the continued issues with regulatory treatment of private debt for banks removing the available supply of credit, credit spreads remaining elevated, and rates continuing to rise, as most private debt are floating rate assets.

LBO/take-private strategies may benefit from the weakness in public equity markets. Weaker overall economic growth can present opportunities for successful managers to strive to turn underperforming public companies around and effectively identify synergies and rectify inefficiencies within target companies.

Conclusion

While many of the challenges experienced in 2022 will continue to affect the economy and markets in 2023, this year may bring a host of new concerns, issues, and conflicts. Rather than worrying about the dynamics of individual assets and markets, investors may find it more effective to consider alternative assets that can capitalize on global uncertainty.

As such, many of the same strategies that performed well in 2022 may continue outperforming the public markets. Investors should identify managers with a long track record through multiple market cycles, diversified portfolios, skin in the game, and independent service providers. While many managers will reap great gains in 2023, investors should exercise caution and diversify their portfolios to strive to mitigate risks.

Innovative ways to plan a REIT Investment

A REIT generally has large investment properties in their portfolio. A REIT usually leases properties to tenants and earns income in the form of rent, which is then divided among its shareholders. In order to qualify as a REIT, a company must comply with the following rules –

How a REIT generates revenue?

Most REITs lease properties to tenants and make money from the rents, which is then divided among the shareholders as dividends. The majority of REITs trade on the National Stock Exchange and can be easily bought or sold. On the other hand, some REITs lend money to investors and earn interests on the loan. As you can see, a REIT’s source of income varies depending upon the sector in which that particular REIT operates.

Varieties of REITs

Profit  = (Annual interest income – annual interest expense)
             =$(3.5-1) million
            = $2.5 million.

The majority of REITs are equity REITs. However, trusts like mortgage REITs or publicly traded REITs also have their own benefits. Therefore, it’s important that you speak to an experienced REIT advisor, who can guide you through each of these REITs more deeply. We do have a team of highly qualified advisors for you. In no time, you could speak to up to three advisors.

A Step By Step Guide for your REIT Investment

Published On - July 26, 2019

It’s an investor’s responsibility to keep searching for different investment options from time to time. Real estate investment requires a lot of patience and a positive attitude even in adverse situations. Buying a property only requires capital. However, maintaining the same property for a long time requires capital as well as a significant amount of time. That’s why some investors prefer mutual fund investment or Exchange-Traded Fund (ETF) over large individual real estate investments. An alternative to a mutual fund or ETF investment is Real Estate Investment Trust.

What is a REIT?

A Real Estate Investment Trust or REIT is a company or trust that owns, manages, and in most cases, operates income-producing real estate properties. REITs allow investors to own shares in real estate properties without the burden of purchasing and managing those properties. The majority of REITs lease spaces to tenants and earn rents on those properties. While some REITs also lend money to real estate developers and earn interest on the loan. This kind of investment requires a long-term commitment and it isn’t for investors seeking short-term benefits.

Who is it for?

Any investor can invest in REITs. Whether you’re a beginner or a pro, a REIT investment offers similar benefits to everyone. However, it may not suit every investor. An investment structure like REIT is more beneficial for retirees or someone who is on the verge of retirement than someone who is young and looking for short-term investments.  As REITs provide a steady flow of income for a long time, it suits people who have already hung their boots or are planning to do so.

What are the different types of REITs?

How to invest in a REIT?

You can invest in a REIT the way you invest in other company’s stocks or bonds. A REIT’s stocks can be easily purchased and sold on the National Stock Exchange. When you buy shares in a REIT, you invest in the trust and not in real estate properties. That’s why a REIT investment doesn’t qualify for a 1031 exchange. Real Estate advisors or experts can help in exploring the challenges that come with a REIT investment.

Should you use FFO or AFFO as a metric to measure a REIT’s cash flow?

Published On - July 26, 2019

Over the years, REIT investment has become a popular choice among real estate investors, particularly among the retirees. With benefits akin to that offered by a mutual fund investment, REIT lets investors invest in real estate properties without the burden of purchasing and managing those properties. The majority of REITs own, and in most cases operates, income-producing real estate properties. They lease spaces to tenants and then collect rents on those properties. Whereas, some REITs lend money to real estate investors and invest in mortgages and mortgage-backed securities.

Equity or Mortgage REIT – Which is better?

Equity REITs own and operate real estate properties. The primary source of income of an Equity  REIT is the rent they receive by leasing spaces to strong tenants. These kinds of  REITs provide high liquidity as their shares can be easily purchased and sold on the National Stock Exchange.

Mortgage REITs (mREITs) function in a different way. They lend money to real estate investors and invest in mortgage and mortgage-backed securities. The spread between the interest earned on the mortgages and the cost of financing the loan determines a Mortgage REIT’s income.

Since the Equity and Mortgage REITs have different working models, both are beneficial in different ways. Investors seeking instant income can go with Equity REITs. However, as they trade on the National Stock Exchange, they are subject to market risks. On the other hand, those who require funds for their real estate adventures may find Mortgage REITs a blessing in disguise.

How to evaluate a REIT’s cash flow?

Some real estate analysts use FFO (Funds From Operations) as a metric to measure the revenue generated by a REIT. There is a whole formula for calculating FFO. Analysts calculate FFO by adding depreciation and amortization in the net income minus any gain from the sale of real estate properties.

FFO = Net income + Depreciation + Amortization – Gain from the sale of real estate

FFO helps in calculating a more precise value as it adds depreciation in the net income and subtracts any gain the REIT has made from the sale of its real estate. Some analysts also use AFFO (Adjusted Fund From Operations),an advanced version of FFO, to get a more precise value. While there is no derived formula for calculating AFFO, it is taken out by subtracting recurring expenditures from FFO that are first capitalized by a REIT and then amortized. It could be some minor maintenance expenses such as money spent on changing floor carpet or repairing damaged ceiling, and so on.

AFFO =  FFO – Recurring Capital Expenditure

Both FFO and AFFO are used by analysts for calculating a REIT’s cash flow, and you too can use either of them. As REITs don’t need to make maintenance expenditures every day, you may ignore it. However, if you need a more precise value, consider subtracting it from a REIT’s FFO.

Do you need to be an accredited investor to invest in REITs?

What does being an accredited investor means?

There is no process of becoming an accredited investor. You don’t  need to apply for a license or pass a test to qualify as an accredited investor. Instead, your wealth or to be precise your annual income determines your accreditation. As per the Securities and Exchange Commission (SEC), to qualify as an accredited investor, an investor must have an individual income of more than $200k per year or a joint income of $300k. Many real estate investment structures accept only accredited investors and non-accredited investors can’t invest there.

What is Real Estate Investment Trust (REIT)?

A Real Estate Investment Trust or REIT is a private trust that owns, and in most cases, operates income-producing real estates. REITs have large institutional-grade properties in their portfolio. Some REITs invest in the commercial sector, while some are inclined towards the healthcare sector. The majority of REITs lease spaces to tenants and receive rents on those properties. Whereas, some REITs lend money to real estate investors and  earn interests on the mortgages and mortgage-backed securities. With benefits akin to that of mutual fund investment, REIT investment offers a steady flow of income for a long time.

Do I need to be an accredited investor for investing in REITs?

No, you don’t need to be one. Any investor can invest in REITs irrespective of how much wealth they possess. You can invest in a REIT just like you invest in the stocks of other companies. The majority of REITs are listed with the Securities and Exchange Commission and trade on the National Stock Exchange. Shares of a REIT can be easily bought and sold on the National Stock Exchange. As a REIT’s shareholder, you’ll be subject to receive dividends like other shareholders.

What are the different types of REITs?

There are three major kinds of REITs where you can invest –

How to plan a REIT investment?

Though you can invest in a REIT with the help of a broker, you may want to consult your financial advisor or a REIT expert before that. As shares of a REIT can be bought and sold on the National Stock Exchange, a REIT investment is subject to market risks.

Private vs. Public REITs: Finding the Best Financial Fit

The reasons why an individual chooses to invest vary; however, most cite earning a high return on investment as one of their financial objectives. Whether it is immediate income or capital appreciation, wealth accumulation is a primary consideration for investors.


One investment that meets this financial objective, while providing additional benefits, is a real estate investment trust (REIT). A REIT is “a corporation that owns and/or manages income-producing commercial real estate. When individuals buy a real estate investment trust … share, they are purchasing a share of the company that owns and manages the rental property.”


Historically, REITs – both private and public – have outperformed the stock market, providing investors with higher returns than equity investments. This article reviews the types of REITs that exist, historical returns for private vs. public REITs, and ways to identify suitable investments for a portfolio.

Types of REITs: Public vs. Private

REITs can be classified as either private or public.

Public REITs

Public REITs are regulated by the U.S. Securities and Exchange Commission (SEC). They must meet certain qualifications and register and file regular reports with the SEC.


Public REITs can be further divided into publicly traded and public non-traded. Anyone can invest in either type; however, the form of investment differs. Publicly traded REITs are traded on an exchange, such as the New York Stock Exchange (NYSE) or NASDAQ. Well-known publicly traded REITs include Camden Property Trust (CPT), Realty Income Corp (O), and The Howard Hughes Corporation (HHC). Meanwhile, public non-traded REITs are purchased by working with an individual broker or financial advisor. Public non-traded REITs offer similar benefits and disadvantages as private REITs.

Private REITs

Private REITs are real estate funds or companies that are exempt from SEC registration and are available only to institutional or accredited investors. An accredited investor is defined as either 1) an individual whose net worth is more than $1 million, excluding their primary residence (individually or with a spouse or partner) or 2) an individual whose income is more than $200,000 (individually) or $300,000 (with a spouse or partner) in each of the prior two years and reasonably expects the same for the current year. Investments are available through private placement and, unlike public REITs, require a higher minimum investment, ranging from $1,000 to $25,000 (sometimes more).

REITs in Terms of the Numbers

Introduced in 1960, REITs have become a vital part of our economy. According to data released by Nareit:

While REITs are a major contributor to the economy, what returns are investors potentially going to achieve when adding REITs to their portfolio? To better answer this question, it’s important to look at the historical performance of public and private REITs and outline the risks associated with each. Accredited investors should consider both factors when determining which REIT to invest in.

REITs vs. Stocks

Before reviewing the difference in returns for private versus public REITs, let’s first look at how REITs perform compared to stocks. The Motley Fool explains that “REITs have outpaced the S&P 500's total return since NAREIT began tracking their performance in 1972. Thus, one could definitively state that REITs have outperformed stocks over the long term.” While “that has certainly been the case in more recent years as stocks outperformed REITs in 2019 and the prior 5- and 10-year periods … REITs have come out ahead over much longer timeframes as they've outpaced stocks during the last 20- and 25- year periods.”

Data reveals that “over a 25-year period, the index returned 9.05% compared to 7.97% for the S&P 500 and 7.41% for the Russell 2000.”

Private vs. Public REITs

Return on public REITs – more specifically, publicly traded REITs – can easily be determined. Since shares are publicly traded, these REITs are required to report their earnings and dividends. Looking at the past 10 years, “ as of June 2022, the index's 10-year average annual return was 8.34%. Over a 25 year period, the index returned 9.05% …”

Private REIT data, however, is not so simple to determine. Lack of transparency makes it more difficult for investors to understand what to expect. To help differentiate between the two, we turn to the expert opinion of Brad Thomas, an experienced real estate professional. Thomas recently shared an article outlining the difference between private and public REITs, pointing out that returns on private

REITs have the potential to be higher than those on public REITs. He recalls one of his experiences, which supports this possibility.

“When I harnessed institutional capital in 2003 and 2011 to co-found two net-lease REITs … the founding institutional investments flowed into STORE Capital (STOR) in 2011 and concluded prior to our 2014 IPO. By the time of their exit in the first quarter of 2016, our founding institutional shareholders had generated returns that exceeded their initial expectations and mine; they made an approximate 26% annual rate of return.”

He shares another example of what investors recently experienced in the private REIT sector. “In 2017, Blackstone (BX) introduced the Blackstone Real Estate Income Trust (BREIT), an open-ended privat REIT designed to deliver private real estate asset management to retail investors. … At the end of June 2022, BREIT's NAV per share had risen roughly 50%, versus just a 10% rise in VNQ's [Vanguard Real Estate Index Fund ETF, a publicly traded REIT] per share valuation. Much of the performance divergence rests in BREIT's investment mix.”

Historically, Thomas said, “had you been a buy-and-hold REIT investor between 1990 and 2022, you could have likely been happy socking away your 10.5% annual rates of return.”

Not all data reveals the same returns; however, most reports share the same concept: private REITs offer higher return potential than public REITs. To provide an alternative opinion, let’s look at an article released by The Motley Fool. According to certified financial planner Matthew Frankel, While Mr. Frankel discusses risks associated with private REITs and why they are not a great investment for everyone, he states that, “Generally speaking, private REITs pay higher dividends than comparable public REITs. Public REITs have historically paid dividend yields in the 5–6% range, on average, while private REIT dividend yields have historically been in the 7–8% ballpark, according to National Real Estate Investor.”

Where to Invest

As mentioned, all REITs – private, publicly traded, and public non-traded – all have unique pros and cons.

Public REITs “are a popular way of investing in commercial real estate, especially for those who have limited funds to invest. REITs have a low barrier to entry; someone can buy a single share for less than $100 … [and] these shares are generally highly liquid … [shares] can often be bought and sold with the click of a button just as you would trade other stocks or bonds. The liquidity of [public] REITs … makes them particularly attractive for those who want to diversify their portfolios by investing in commercial real estate, but who cannot or do not want to have their capital tied up for extended periods of time.”

By contrast, those looking for higher return potential should consider private REITs. However, investors must consider the associated risks. Private REITs are

The key to any portfolio is diversification. Incorporating a REIT option, including a private REIT, may protect investors against economic volatility. Those interested in learning more can speak with a qualified professional at Perch Wealth.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only, and should not be relied upon to make an investment decision. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

Real Estate Risk Disclosure: