If you are considering diving into the world of real estate investments—particularly commercial real estate investments—you’re probably hearing many terms you’re not familiar with. Some key terms you need to understand include ‘private equity real estate’ (PERE) and ‘real estate investment trust’ (REIT).
Both PEREs and REITs are private real estate investments that are essentially organized pools of capital that are invested in real estate. However, there are key differences to each and one may be a better fit for you over the other. Let’s define both PEREs and REITs in detail, as well as their advantages and disadvantages.
What Is a PERE?
PERE is an acronym for private equity real estate. First National Realty Partners (FNRP) is perhaps one of the most well-known examples of a PERE. Purchasing FNRP stock is not as straightforward as buying into a REIT. Most PEREs, including FNRP, require certain categories of investors to invest with them. They include:
- High net-worth individuals (HWNIs)
- Private accredited investors
- Institutions and third parties, including nonprofit funds, pension funds, and asset managers
Typically, if you do not fall into one of the above categories, you will not qualify to invest in a PERE. A PERE is composed of professionally-managed pooled private and public investments in the real estate market. The process involves acquiring, financing, and either direct or indirect ownership of a property via the investment fund.
PEREs are ideal for accredited investors with high risk tolerance and no need for immediate liquidity. It is important to have a longer time horizon in order to reap the full benefits of your investment.
There are several advantages to investing with a PERE. Here are a few key benefits:
- Efficient: PEREs are designed to be large enough to take advantage of real estate opportunities while remaining small enough to mitigate the chaos associated with managing too many employees and brokers. The focus remains, instead, on making assets successful and generating returns.
- Increased stability: This asset class is generally stable and firms like FNRP offer strategies to protect against inflation costs, increasing your chances of profit.
- Tangible assets: Unlike REITs, the properties you fund are either completely or in part, yours. You own real property and can generate income based on the profitability of the property, rather than relying on the changing value of a piece of paper.
- Higher return potential: PEREs can find opportunities across multiple asset classes and multiple locations to target higher returns. There aren’t limits or prohibitions regarding investments that need work and can potentially deliver higher returns than a REIT or public markets.
You can’t have your benefits without your costs. Here are the downsides to investing with a PERE:
- Higher initial investments: Firms like FNRP require their accredited investors to start investing at a minimum of $50,000. Your upfront costs are greater, and due to the nature of PEREs, it may be some time before you see a return on your investment.
- Less liquid: Unlike REITs, real estate cannot be converted into cash with a snap of your fingers. You own the property and must go through the proper channels of selling your share of it, which can take months or years to secure the market rate you want.
What Is a REIT?
A REIT is a real estate investment trust that owns, operates, or finances properties that produce income. A REIT can be used for commercial, residential, healthcare, or mortgage purposes. What is a commercial REIT? This type of REIT refers to investing in properties used for business or commercial purposes, where the profit comes from the income collected via tenant rent. For more information on profits, be sure to check out our article on the 50% rule in commercial real estate investing.
They can be both publicly and privately traded, but private REITs usually require experienced investors with substantial assets. Otherwise, almost anyone can invest in a REIT.
Here are the benefits to investing with REITs:
- Accessible for all: Unlike with PEREs, publicly-traded REITs don’t always require higher upfront costs. Some REITs allow you to buy shares at as low as $1.
- Mandatory distributions: The Internal Revenue Services (IRS) requires all REITs to distribute 90% of their taxable income to shareholders. You will typically see these payments in the form of annual dividends.
- Liquid assets: Because these stocks operate the same way other stocks can be bought and sold, investors can easily turn their investment into cash.
- Security: REITs are often pitched to retirees because they generally produce a regular, dependable income. They collect rent and mortgage interests, which makes them a solid investment.
Every rose has its thorn, and REITs are no different. Here are some key disadvantages to investing with REITs:
- Taxes: REITs are taxed as income, meaning they are not given the preferential tax treatments other real estate investment returns receive. We recommend discussing with your financial planner if these returns will push you into a higher tax bracket.
- Slower capital appreciation: REITs don’t typically grow in value as quickly as other investments, meaning the return on your investment might take a little longer.
- Interest fluctuations: REITs are most sensitive to interest fluctuations and suffer in environments with rising interest rates. As rates rise across the board, your shares can depreciate in value relative to other shares.
The Bottom Line
Both REITs and PEREs are ways to get in on investing in real estate. PEREs are a better fit for HWNIs or asset managers and REITs can be accessible for investors from all income and experience levels. REITs are more heavily regulated by the IRS, which offers as many protections as it does stipulations. To find out if a PERE or an REIT is the right fit for you, consult with your financial advisor today!