Why I Quit Private Equity Real Estate To Buy REITs Instead

I come from a family of real estate investors.

Almost all the money my parents ever made was invested in real estate.

So I naturally felt a sense of familiarity with him.Growing up, I visited regularly At the construction site, I discuss real estate transactions with my father.

Eventually, I went to college to study real estate investing and got a job in private equity real estate.

My company was much smaller than Blackstone (BX), Brookfield (bam), or KKR (KKR). At that time, we primarily made small deals in the $1 million to $10 million range and had a Realty Income Corporation (〇) is targeted.

I liked it The idea of ​​buying property primarily with bank money and having tenants pay off mortgages attractive to me.

Add to that the cash flow, valuation, and tax benefits and you’ve got a big payoff.

But in the end, I learned more about real estate investment trusts (REITs) (VNQMore). These are listed real estate investments. We quickly came to the conclusion that, in most cases, these were far better investments than private equity real estate.

This made me quit private equity and become a REIT analyst looking for superior risk-adjusted returns. Ultimately, I founded my own REIT investment firm, Leonberg Capital. That’s also what brought me to Seeking Alpha, which covers many of my favorite her REIT investment opportunities.

Here are five reasons why REITs are better than private equity in most cases. When I say private equity, this includes large funds like Blackstone, but also smaller players using crowdfunding like Fundrise, Cardone Capital.

Reason 1: REITs generate higher total returns over time

Private equity players typically advertise high expected returns when raising capital. A good example is Cardone Capital and its target IRR of over 20%.

In reality, however, the targeted IRR is rarely achieved. Since this is largely marketing and ‘pro forma’, you can use the assumptions necessary to achieve these projected revenues.

In reality, the average rate of return on private equity real estate is fairly low, approaching 8-10% per year. This is still pretty good, but he’s actually a lot worse than REIT returns.

A lot of research has been done on this topic and the conclusion is that REITs are outperforming by an average of 2-4% per year.

How is this possible?

This is a surprising result for many people when they first hear it, but it actually makes sense when you think about it.

REITs are much more rewarding because:

1) They enjoy huge economies of scale. REITs often own 1,000 properties in one market, which translates into significant savings on all fronts. Management. construction/renovation costs. lease. Such. Imagine a REIT contracting with a contractor to replace 1,000 carpets in a city each year, and a private fund owning one or several properties. Prices vary greatly.

2) They have access to cheaper public capital. REITs can raise funds through the open market. They often have access to public equity at a premium to NAV, preferred stock, convertible bonds, bonds, etc. This diversity and better access can reduce capital costs and widen investment spreads.

3) Not limited to organic growth. Private placement funds are limited to growing the same property NOI. But REITs can also grow externally by raising new capital. As long as the target return is higher than the cost of capital, there is a positive spread that boosts the total return. REITs, like real estate income, are growing more than 5% a year despite only a 1% increase in lease payments. Private equity can’t compete with that.

4) You can enter other real estate related businesses and make profits. REITs often use their vast platforms to serve other investors as well, and these profits are shared with their shareholders. As an example, Armada Hoffler’s properties (oh oh) is construction services, SL Green Realty (SLGMore) provides property management services and Farmland Partners (FPI) provides brokerage services. Private real estate funds are managed externally by an outside asset management company and therefore do not share such profits with you.

Five) They are better aligned with shareholders. Most REITs are managed internally. That is, the manager is employed as an employee of her REIT and receives a salary that is a function of shareholder value creation. Private funds, on the other hand, are externally managed by external companies that earn fees that are primarily a function of assets under management, and seek to grow as large as possible to earn higher fees, creating a significant conflict of interest.

6) They skip real estate transaction costs. Because REITs are so large, they also have unique relationships with other property owners and tenants. This allows you to skip expensive brokerage fees and other transaction costs. Unless you are a huge private equity player, transaction costs will pay more.

7) Strong bargaining power with tenants. Because REITs are large vehicles and highly diversified, you have more leverage when negotiating with REITs. Private equity vehicles often have tenants holding cards because he usually only owns 1-10 properties in one entity. They know vacancies will be a big problem for them.

And there are many other reasons!

Reason 2: REITs are a much safer investment

Private equity players would argue that they are safer than REITs because they are less volatile.

But this is also incorrect.

Private equity funds are typically concentrated, illiquid and highly leveraged.

REITs, on the other hand, are typically decentralized, liquid, and conservatively leveraged.

How can you say REITs are riskier?

it’s the other way around. Just because it’s not listed and doesn’t have daily liquidity doesn’t mean its stock value won’t fluctuate much. On the contrary, it is much more volatile as it is concentrated, illiquid and highly leveraged. Without access to information and ignoring volatility, its value is not stable.

This topic is covered in detail in a recent article Youtube video.

Reason 3: REITs provide liquidity and control

Recently, Blackstone (BX) made headline Many investors tried to sell off one of the unlisted real estate entities because of limited redemptions.

That is illiquidity.

The tenor of most private equity vehicles is about 10 years. So unless the general partner allows another investor to sell your stake, you simply cannot get out.

REITs are liquid and controllable.

You can always leave with just a few clicks of your mouth. It’s quick and easy. If the REIT suddenly becomes unattractive because real estate fundamentals start to deteriorate, he can sell it and invest elsewhere.

This greater flexibility allows you to earn higher total returns over time.

In a private equity vehicle, you’re stuck whether you want to keep investing or not.

Reason 4: REITs align the interests of managers and investors

Show me the incentive…and I’ll show you the end result…

I touched on this briefly earlier, but I want to add it to really get this point across.

Private equity vehicles are externally managed and the manager’s interest is in maximizing fees, usually achieved by increasing assets under management. Sophisticated marketing can achieve this, even if the results are questionable. After all, their funds are illiquid and private, so you can’t know about the outcome anyway. may sell its assets. This allows us to raise more capital and earn more fees. A manager also manages many other vehicles at the same time, creating a conflict of interest.

Since REITs are managed internally, incentives are better aligned. A manager is an employee whose salary/bonus is a function of her REIT’s performance. Their sole focus is this one REIT they work for.

This seemingly small change in management structure alone can significantly reduce risk and increase return over time.

Let’s take a look at how private equity real estate players bought properties that led to major financial crises. They were buying to raise fees. REITs, on the other hand, were selling to REITs because their interests were more aligned.

Again, show me the incentive…and show you the end result…

Reason 5: REITs can be purchased at deep discounts and save fees

Finally, and perhaps most importantly, REITs allow you to invest in real estate at a significant discount to fair value.

It is not uncommon for REIT-owned real estate to trade at discounts of 20, 30, 40, or even 50% to the underlying value. This essentially means that you can buy real estate for a dollar cent.

To name a few:

Vonovia (VNA / OTCPK: Bonoi), Germany’s largest listed apartment owner is currently priced at just 40% of its net worth. That’s a 60% discount.

Camden Property Trust (CPTMore) is one of the largest apartment owners in the rapidly growing Sunbelt market in the United States, currently selling at an estimated 30% discount.

SL Green, New York City’s largest Class A office landlord, is currently priced at an estimated 50% off its net worth.

Due to stock market volatility, there are regular such opportunities in the REIT sector. Since most equity investors are short-term oriented, there is a lot of inefficient pricing in the REIT sector.

But when you invest in a private real estate fund, you pay the full price. You will get an up-to-date net asset value, plus you will be paying commissions and other fees.

Saving these commissions alone can give you a head start, and the added discounts increase your earnings and provide a margin of safety.

Conclusion

Most real estate investors believe they can get better returns with less risk by investing in REITs than fancy private equity real estate vehicles.

It’s not cool. There is no feeling of being part of an “exclusive” group.

However, research shows that REITs perform better and are less risky. This is why I eventually quit private equity and became a REIT investor.

Editor’s Note: This article describes one or more securities that are not traded on any major US exchange. Please be aware of the risks associated with these stocks.