With real estate remaining a popular investment asset class, investors must understand the best structures for accessing these investments. The two most common are limited partnerships and REITs. Limited partnerships allow investors to pool capital under a general partner who makes all investment decisions. REITs are companies that own and operate real estate assets and trade publicly like stocks. Both offer different benefits in terms of control, diversification, liquidity, and fees. This article will further explore the key distinctions to determine the optimal structures for real estate investing.
Limited Partnerships Enable Active Management with Less Liquidity
Many private real estate funds are structured as limited partnerships (LPs), with a general partner (GP) managing the investments and limited partners (LPs) providing the capital. LPs have limited liability and no control over investment decisions, while the GP has unlimited liability but full control. LPs benefit from the active management expertise of the GP. However, LPs usually cannot sell their partnership stakes, making this a relatively illiquid investment. LPs also pay management fees (1-2% of assets) and performance fees (10-20% of profits) to the GP.
REITs Provide Liquidity and Diversification
Real estate investment trusts (REITs) are companies that own and operate real estate assets like office buildings, apartments, hotels, etc. REITs allow individual investors to gain exposure to institutional-quality real estate by purchasing publicly traded shares. Investors benefit from daily liquidity, portfolio diversification, and professional management. There are no performance fees, but management fees reduce investor returns. On the downside, investors give up control and access to private deals.
Overall Flexibility Favors Limited Partnerships
For accredited investors who meet minimums, limited partnerships arguably provide the best structure for real estate investing. While less liquid, LPs offer access to actively managed private deals and potential for higher returns compared to public REIT investments. The ability to tap the real estate expertise of a GP with alignment of interests is a significant advantage. REITs remain a good option for liquid real estate exposure, however.
Consider Hybrid Structures and Funds of Funds
Some investment structures attempt to combine the benefits of limited partnerships and REITs. For example, non-traded REITs are publicly registered but not listed on an exchange, providing periodic liquidity options. There are also real estate sector-specific LPs that focus on areas like self storage, medical office, etc. Investors can also diversify through a real estate fund of funds (FOF) which invests in multiple underlying real estate partnerships.
Weigh Tax Differences Between Structures
There are tax considerations that may influence the choice of investment structure as well. Limited partnerships provide the benefit of pass-through taxation, as investors pay taxes on their allocable share of income at their individual rate. REITs avoid corporate taxation by paying out 90% of taxable income as dividends, but investors pay taxes on these dividends. Overall, the tax efficiency of LPs makes them more advantageous in many cases.
In summary, limited partnerships present the best structure for most investors to access private real estate investments. REITs serve a role for liquid and diversified public real estate exposure. The ability to tap professional GP expertise and mitigating taxes favor private limited partnership real estate investing for accredited investors.