While there are many benefits to investment in real estate, the barriers to entry are high for investors going the traditional route of acquiring physical real estate. In addition to the hefty capital needed, significant time, effort and expertise are required to research markets, originate deals, source for loans, manage the properties, handle all the documentation etc. These challenges are further compounded when the properties are situated overseas.
The allure of real estate co-investments and REITs is easy to appreciate, considering both investment avenues allow investors to gain exposure to the asset class without being burdened by the aforementioned issues. While both options share many similarities, they have differences that could be relatively less obvious. This article does not champion either investment mode. Rather, it seeks to objectively examine how investments through co-investments and REITs compare with each other. The discussion will be organised in the following manner: aspects where REITs are more advantageous, areas where co-investment platforms are superior, and considerations where neither have an obvious edge.
Strengths of REITs
Publicly traded REITs are easy to buy and sell while investors using co-investment platforms face liquidity constraints on two fronts.
- Some platforms stipulate a minimum holding period. Even after expiry of the holding period, trading could be limited by the lack of a mature and sizeable secondary market.
- Co-investment platforms usually seek to dispose properties after a specified holding period with the proceeds going towards realising total return and principal repayment for investors. There is no guarantee that a suitable buyer can be found when sought. This risk can be mitigated if investors choose experienced managers and stick to relatively liquid markets.
The minimum investment threshold for REITs traded on public exchanges is extremely low, ranging from just a single share to 100 shares, depending on the jurisdiction. The threshold for co-investment platforms varies. While it can be as low as $1,000 for some platforms, most would stipulate a higher minimum investment amount.
Dollar cost averaging is a simple investment strategy which can be deployed to manage timing risk. While this is easily executable for investments in REITs, it is less feasible for investments on co-investment platforms. The relatively higher minimum ticket sizes for the latter is potentially an obstacle. And while investors could possibly make multiple purchases within the same syndicated property, the investment window closes once the syndicate is fully subscribed.
Strengths of Co-Investment Platforms
Investors on co-investment platforms have absolute control and transparency over which opportunities they would like to seek exposure to. They are empowered to select the specific deals – geography, sector, nature of investment (see article: The Real Estate Risk/Reward Spectrum and Investment Strategies) – that would serve their investment objectives well.
While many REITs follow general investment themes, eg. Grade A office in Singapore, retail malls in Indonesia, outlet malls in China etc., investors have no say in the construction of the REITs’ portfolios. There have also been instances when managers of certain REITs veer off from an initial pure-play theme to pursue a different “investment strategy”. It is common for the compensation of REIT managers to be tied to their assets under management (AUM), creating the incentive to enlarge the AUM in a way that could arguably be a negative for certain investors.
Because REITs are obligated to distribute the bulk of their income and maintain a conservative leverage position, they need to raise capital for new acquisitions. Often, this is by way of rights issues and investors may be compelled to invest further to prevent dilution of returns.
More Diverse Opportunity Set
REITs focus mainly on mature, income producing assets and tend to trade these assets less frequently. Depending on the jurisdictions where they are listed, some might have modest leeway to engage in development and value-added projects. Consequently, REIT investors are largely confined to just the core segment of the real estate investment spectrum. Almost by default, REITs can only acquire assets that are yield accretive. This further narrows the universe of opportunities available to them. Co-investment platforms on the other hand, depending on their offerings, offer the gamut of investment strategies that might better serve sophisticated investors looking to calibrate their portfolios. Investors are able to invest into other parts of the capital stack (mezzanine loans for example) or more opportunistic projects higher up on the risk-return spectrum.
Exposure to Stock Market
Publicly-traded REITs are exposed to the vagaries of stock market volatilities. Although REITs are touted as an effective way to diversify a stock portfolio, the performance of REIT shares have closely tracked overall equity market performance, resulting in high positive correlations (coefficient as high as 0.86 during early 2011) and undermining their diversification value. The inherent inflation hedging virtue of real estate investment is also impaired when REIT share prices are affected by such a wide myriad of factors. On the other hand, real estate investments through co-investment platforms are largely insulated from stock market fluctuations.
Investors through co-investment platforms are able to harness the power of leverage more extensively whereas REITs are bound by regulations to relatively limited leverage headroom. While leverage is a double-edged sword that can be a bane or boon to investors, having that wider berth to manoeuvre is a positive for co-investment platforms. Skilled and experienced project sponsors are able to responsibly employ leverage to boost returns for investors.
This is a point that can be argued both ways. Many REITs are backed by an extensive portfolio of assets, providing instant diversification. Syndicate co-investing involves one property at a time. Investors would need to buy a handful of properties to start approaching a diversified portfolio. Seen from this micro perspective, REITs clearly offer better diversification. However, as mentioned earlier in the article, co-investment platforms offer investors access to a broader opportunity set. From this wider context, co-investment platforms are better placed to offer diversification to investors, allowing them to calibrate their individual portfolios for better diversification. It has also been highlighted earlier that REITs are exposed to stock market fluctuations in much the same way that equities portfolios are. This further reduces the diversification value investors can extract from REITs.
Whether REITs or real estate co-investment is the more suitable channel is situational and dependent on individual investors. There is room and purpose for both investment modes to co-exist within an investor’s strategy. For investors seeking superior returns and have a longer investment horizon, real estate co-investing is the better investment channel. It grants sophisticated investors better use of leverage, exposure to middle market opportunities, participation in value-add/opportunistic strategies and access to other parts of the capital stack. Real estate co-investment is able to provide the flexibility for investors to generate alpha by capitalising on investment themes at a micro level.
Originally published at realvantage.co/insights on June 25, 2019.
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