An Overview of REITs vs. Private Placements
Investing in real estate can be an effective way to generate passive income for many years or decades to come. In fact, depending on how your investments are structured, it may be possible to pass your holdings to your children or grandchildren. If you are going to invest money in real property, you will likely do so through a real estate investment trust (REIT) or through a private placement. Let's take a closer look at the differences between these investment vehicles and how to decide which one is right for you.
Private Placements are More Restrictive Than REITs
A private placement is an invitation to buy an ownership interest in an investment opportunity that is not available to the general public. Often, these invitations are extended to accredited investors, wealthy individuals and financial institutions. As a general rule, private placements are considered to be an alternative to an initial public offering (IPO) for entities that need capital quickly. For the most part, any member of the general public can purchase shares in a commercial or residential REIT. In some cases, individuals may be required to meet initial investment requirements or maintain a minimum account balance to remain an active member of a trust. However, there is no need to be an accredited investor or meet other financial requirements.
REITs Tend To Be More Liquid Than Private Placements
Investing in REITs may be ideal if you want to be able to withdraw your profits in a timely manner. They can also be ideal if you are looking for monthly income as a real estate trust is required to distribute at least 90% of its revenue to shareholders. However, if you are looking to build wealth over a period of years or decades, it may be in your best interest to put your money into private placements. Private placements may be the better wealth building tool in such a scenario because you obtain an equity stake in the properties that the fund invests in. Therefore, you get to deduct depreciation and other expenses on your tax return.
Private Placement Funds Tend to Invest In Better Properties
As a passive investor, you want as much stability in your investments as possible. In most cases, private placement funds tend to feature the same assets for years or decades at a time. This is because fund managers conduct a significant amount of due diligence before deciding if they want to risk your money on a new project. Fund managers have to spend so much time conducting due diligence because they want to make sure that a project is worth pursuing before spending time making a sales pitch to investors. Ultimately, if a given project does make its way into a private placement fund, you can feel confident that it will have a good chance of generating consistent future returns. This is important because these types of investments tend to be less liquid, which means that it can be harder to cut your losses in a timely manner if the investment doesn't work out. Conversely, REITs tend to receive a consistent inflow of cash, which means that fund managers have to consistently find new ways to spend it. While a REIT won't intentionally pour capital into mediocre properties, the criteria for investing in a given home or warehouse is unlikely to be as stringent.
You Get Direct Access to Private Placement Fund Managers
Putting money into a private placement fund is generally seen as a passive investing technique. However, even as a passive investor, it is important that you know how your money is being spent. In most cases, you'll be able to speak directly to whoever is in charge of the money being used to develop a new commercial facility or create a new housing development. If you invest in REIT, there is no guarantee that you'll be given an opportunity to speak with the team tasked with overseeing your money.
Private Placements Make It Easier to Diversify Your Portfolio
Diversifying your portfolio makes it easier to protect and grow your wealth both now and in the future. In many cases, REIT shares are traded much like stocks, ETFs or mutual funds. This means that their overall performance will mirror the performance of the stock market over any given period of time. However, taking part in a private placement is more like becoming a part-owner of the property that is being built or renovated. Therefore, you can get the diversification that you want without having to actively manage a home or building.
Which Option Is Better?
If you are an accredited investor looking for stable returns on exclusive projects, a private placement might meet your passive investing needs. However, if you are simply looking for an easy way to gain exposure to real properties without having to buy a house or lot of land, a REIT may best meet your needs. In some cases, it may be possible to create a steady stream of passive income by placing money into both a REIT and a private placement. Ideally, you will speak with a financial advisor before implementing any type of a wealth building strategy.