How Does a Private REIT Structure Work?

REIT

REIT stands for real estate investment trust. It is a company that is involved with the operation, ownership, or financing of real estate that produces income. An REIT investment is similar to a mutual fund and it is a type of investment that offers a variety of income streams, long-term capital appreciation, and diversification. The REITS are a popular investment type for diversification of a portfolio when the investor is interested in reducing the overall risk of the portfolio and enhancing the probability of ROI. Private REIT structures are a bit different than publicly traded types. Here is how the private REIT structure works.

The Private REIT structure

A private REIT is an investment in a company that has been classified as being exempt from SEC registration. The shares that are sold as investment vehicles are not publicly traded on the national stock exchanges. This type of share is not usually available to individual investors, but rather, are sold to institutional investors. While publicly traded REITs must provide disclosures under Regulation D rules of the SEC registration, private types are not required to do so, nor are they required to provide performance data through an independent or public source.

How are private REITs purchased

REITs are issued in accordance with securities laws that are overseen by the SEC. They must conform to the rules that are established under Regulation D. What this means for investors is that only those which are qualified as accredited investors and further, as institutional buyers may purchase shares.These rules are found within Rule 144A. They’re usually sold by a broker/third party.

What qualifies investors to purchase private REITs?

Accredited investors have been defined as individuals who have a net worth of not less than $1 million. This does not include the value of the primary residence. Additional requirements are an income that is over $200,000 annually for the past two years for single persons. If the investor is married, this figure increases to a minimum salary of more than $300,000 for the past two years. Other qualified investors include large pension funds or other institutional investors. This narrows the pool of qualified investors for private REITs.

Other features of the REIT structure

The liquidity of the shares differs from public REITS. Redemption for private REIT shares are governed by the seller and there may be limited or no liquidity, and the redemption programs might change, as determined by the owner/company. There are also variations in the brokerage expenses from one company to another. It’s important to understand the transaction costs levied by the company you’re investing in. These include but are not limited to promoted interest, or a percentage of the profits, annual management fees, and formation fees.

Investment amounts

Private REITs tend to require higher minimum investment amounts. Again, they are set by the individual company. Investment minimums are generally between $1,000 on the low end, up to $25,000, but some companies may require higher minimum investment amounts.

Management structure

Companies issuing private REITs are generally managed and advised externally. Directors overseeing the board are generally set in place through an election process made by investors. This provides investors with a degree of control or input in the direction that the company takes. Unless an independent director is a registered investment advisor, the company is usually exempt from oversight and regulatory requirements. This is outlined in the Investment Advisers act of 1940 which is still in force. There is no requirement for corporate governance other than a board of trustees or a board of directors.

Pros of private REITs

There are three major advantages for private REITs. When compared with public REITs, the private type have lower compliance costs. This is because there are fewer corporate governance, and financial reporting rules. This saves a considerable amount of money and it can make privately held real estate investments of this type less expensive when it comes to the associated costs and potential for profit.

Private REITs compared to public types pay higher dividends in most cases. The difference can be as much as 2 to 3 percent higher. For many investors, this makes them a more attractive investment option. There are no daily fluctuations in the market. The share prices for private REITs are calculated on a quarterly bases verses the daily basis of publicly traded stocks. This helps to lessen the stress associated with these fluctuations. It offers investors a little more peace of mind because there is no need to obsess over daily ups and downs of the investment. It becomes one of the less worrisome investments in your investment portfolio.

Cons associate with private REITs

As with any type of investment, there are a few potential downsides to private REIT investments. One of the most concerning for some investors is that private REITs do not offer the same degree of transparency as public investments. This is because they are not as heavily regulated. You may not be aware of the decisions that are made by management of a company and decisions made may not be in investors’ best interest. Full disclosures are not required and you may not be able to find any solid performance data to track your investment.

Limited to no liquidity

Another potential drawback is the lack of liquidity for private REITs. It’s not as easy to cash them out. This is an area where most publicly traded REITs offer an advantage over the private. Redemption of shares may be extremely restrictive and each company sets their own rules without interference from regulatory bodies.

You must qualify to invest

Individuals must meet the qualifications to be considered an accredited investor. You must have a minimum of $1 million in assets minus the value of your residence, plus bring in an annual income of at least $200,000 per year, and have done so for the two years prior to making the investment.

Higher commissions

In most cases, private REITs go through a broker who charges commissions that are generally higher than publicly traded REITs. Much of your investment could go towards the commission cost, which can reach from 12 up to 20 percent. You lose a lot off the top of your initial investment in commission fees. Although not all of the commission fees are this unreasonable it’s important to know that some are.

Conclusion

Private REITs are structured differently than publicly traded REITs. There are advantages and disadvantages associated with this type of investment. When you understand the structure, it helps to know what to look for if you’re considering making this type of investment.

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