WHY DON’T I JUST BUY A PUBLIC REIT? | A Concise Comparison Between Public & Private REITs
By: Marcin Drozdz & Steve Froese
With record low interest rates combined with how well real estate assets have weathered the storm in Canada over the years; it is no wonder that this asset class has become the proverbial talk of the town. That said, for those of you considering alternative investments, specifically Exempt Market securities there is one question that seems to pop up from time to time: Why would I invest in a private real estate opportunity when I can just own a publically traded REIT?
Given the amount of capital that has flown into real estate over that last few years, it is a fair question. Between residential, commercial and industrial real estate there are many ways to get into the market but for the purposes of this article we will focus on the fundamental differences as they pertain to the positives and negatives between public REITS and private real estate options.
Three substantial reasons why investors and advisors should consider private real estate investments:
1 No Direct Correlation To The Ups & Downs Of The Stock Market
On December 15th 2008 the Great-West Life Real Estate Fund suspended redemptions as it did not have enough cash on hand to satisfy the sudden onslaught of requests for liquidity. At the time, the fund owned 155 buildings with a stated gross market value of 3.37 billion, predominately invested in commercial buildings, which are like illiquid assets. As we all know the second half of 2008 was a tough time for most public companies and the vast majority of small and large cap businesses were left with share prices cut nearly in half. With unprecedented world economic events, the public markets as a whole had fallen out of favor with many investors and the mass exodus to cash forced funds like the Great-West Life Real Estate Fund to sell assets to meet burgeoning cash requirements. Businesses sold for pennies on the dollar and perfectly good, income producing real estate assets of all sizes sold at deep discounts across North America.
On the other side of the equation, private investors and investment funds eagerly purchased these businesses and buildings. These private organizations and wealthy individuals saw the incredible value fundamentally built into these businesses and real estate assets and had the ability to patiently hold them, and benefit from, their existing income. Fast forward to 2013 and many of those same assets are resurfacing on the market at a substantial premium as public confidence grows. Seasoned, well-heeled private investors and the private investment funds are able to stay strong and profit from these ups and downs as private real estate offerings are traditionally not directly correlated to what’s happening in the stock market.
2 Less Upfront & Ongoing Costs
The costs of transforming into, and maintaining, a public company are steep. Many private real estate investment companies that have decided to initially make the move are inundated with new costs, administrative overhead and restructuring costs. These factors noticeably bring down their bottom line from where they were before they decided to go public.
3 Participate In Niche Markets/Offerings
Public REITs are generally massive with hundreds of millions, or even several billions, of dollars in assets. Combined with the overall success of REITS in Canada, and the mostly favorable press as of late, significant inflows of investment capital continue to arrive daily from investors. With this influx of that money coming into the sector, the REITS will (and are) inevitability going to start stepping on each other’s toes as the need to deploy capital into assets heats up competition. There are only so many large assets to acquire (most REITS will not look at buildings for less than 10 million dollars). In addition, with multiple buyers jockeying for position it only makes sense that sellers can hold out for the highest price.
Private investors and private investment funds are typically smaller in size (relatively speaking) and do not compete for the largest assets, as they typically do not have the required hundreds of millions of dollars on hand. Also, in most cases, they do not want to get into bidding wars with those that do. To the contrary, many times it is the private investors or private investment funds that sell their assets at a considerable profit to larger players who have different return on investment goals.
That being said, private real estate opportunities also present new variables that need to be considered in relation to publicly traded REITS. Three important risks associated with private real estate investments are:
4 Less Requirements For Disclosure
Private real estate investment companies are not required to provide investors a prospectus, which is a full disclosure document that is filed with the Canadian securities regulators. Although private investment companies can reduce costs by not preparing a prospectus to raise capital, it also removes the associated disclosure requirements. Today the most common way for eligible and/or accredited investors (depending on the province) to access private real estate investments is through an Offering Memorandum. Retail investors can work with Dealing Representatives that are licensed with Exempt Market Dealers to get their questions answered about the details of the private real estate offering they are considering.
5 No Boost From The Market When It Is The “Flavor Of The Month”
Private real estate offerings are not traded on any stock exchange, and as such do not go up in value when the stock market does. When public markets are strong and a certain sectors are favored, it has been shown to bring up the value of other similar assets and/or companies. Private real estate offerings do not directly benefit from such a move in the markets. However, the tradeoff here is that they also do not directly decline in value when public markets do.
6 Reduced Or No Liquidity
Private real estate offerings are typically illiquid or have a reduced degree of liquidity. When someone commits to investing in a private real estate opportunity it is typically associated with a specific strategy or focused acquisition that will require a certain amount of time to execute. This can be viewed both as a gift and a curse depending on how you look at it. Most people feel that investing in public market securities implies a strong degree of liquidity and they are mostly correct. In the extreme case of the 2008 crash even public securities such as the aforementioned became illiquid. It is important for investors to work with their Dealing Representative to fully understand what their liquidity requirements are and whether the potential for a higher return is worth the risk of illiquidity for a number of years.
Ultimately, real estate assets have stood the test of time and have proven to be one of the best stores of value, protectors of wealth and some of the most consistent income producing investments known to man. Like with any investment class, the management team and business plan are fundamental to the success of the enterprise (regardless if it is a public or private offering) and once those things check out it is a matter of determining what the goals of the investor are. If an investor or advisor is considering a real estate investment and is comfortable with the strength of the offering, amount of disclosure, and the general illiquidity; private real estate offerings is certainly an asset worth exploring.