Investing in commercial real estate can look attractive when you want your money tied to rent-producing assets rather than public-market speculation.
To do this, you can either buy shares in a real estate investment trust or buy a commercial property directly and manage it.
Both routes can give you access to CRE. They just work in very different ways.
As a general rule:
- REITs suit investors who want easier access and less day-to-day responsibility
- Direct ownership suits investors who want more control and have enough capital to take on the work that comes with owning a property.
For most first-time investors, the better starting point is usually a REIT, simply because owning a commercial property demands not only more time and money but also more real estate experience.
What happens when you invest in a REIT?
As you probably already know, a REIT (real estate investment trust) is essentially a company that owns commercial real estate.
Some REITs deal only in one type of property (such as industrial buildings or apartment buildings) while others own properties across different segments and locations.
When you invest in a REIT, you are buying shares in that REIT company.
You do not directly own part of each building — instead, you own shares in that company, which owns and manages income-producing properties.
If the REIT earns rental income and distributes dividends, you receive your share based on the number of shares you own.
What happens when you invest directly in a commercial property?
You buy a property yourself, ideally through an LLC or another ownership structure.
As the direct owner of the asset, you can then collect rental income and keep the profits after expenses.
You also have to make management decisions and pay the ongoing costs needed to keep the property running.
As the owner, you carry the risk if the property underperforms.
Why are REITs usually better suited for first-time investors?
Lower starting cost:
REITs make it easier to enter commercial real estate. You don’t need a large down payment.
You can start with a smaller amount of capital and build exposure over time.
REITs that trade on public stock exchanges are also very easy to buy through a brokerage app or online brokerage account.
Easier exit:
Publicly traded REITs are also much more liquid than direct property ownership, as you can sell your shares through the market if you suddenly want out or need to raise cash.
The price may rise or fall as it does with any publicly traded investment, but you don’t have to wait months to sell a physical property.
Less hands-on work:
REITs also place the property work in the hands of experienced managers who handle acquisitions, leasing, financing, maintenance decisions, and tenant relationships.
As a shareholder, you receive passive exposure without managing the asset yourself.
Regular dividend income:
Did you know that by law, REITs must distribute at least 90% of their taxable income to shareholders each year to keep their REIT tax status?
Much of the rental income from the REIT’s properties flows back to investors as dividends instead of staying inside the company.
This is one of the main reasons REITs often appeal to investors who want regular income from commercial real estate.
Are there any trade-offs to investing in REITs?
REITs don’t give you control over what properties the company buys or what financing it uses.
You also don’t decide how each property in the portfolio is managed.
And because public REITs are traded like stocks, the share price can rise or fall even when the properties themselves are earning a good income.
Dividends are not always taxed lightly.
A high dividend yield does not automatically mean a better return.
Check what you keep after taxes before you compare one REIT against another.
Why does direct CRE ownership appeal to some first-time investors?
Mainly because direct ownership means control.
You choose the property and how to run the asset.
If the property performs well, you may keep all the income and benefit from any increase in value.
Some investors prefer direct ownership because they know a local market well or have experience with a certain tenant type, so they’re confident that they can keep the property leased and manage the costs profitably.
Direct ownership may also give you depreciation benefits, meaning you can deduct part of the building’s value over time and reduce the taxable income from the property.
The rules are technical, so be sure to review the deal with a tax adviser before you buy.
Are there any trade-offs to owning CRE directly?
Buying a commercial property requires serious capital and time commitment. It is by no means a passive investment.
Expect to handle many of the ownership tasks yourself, unless you hire a management team to run the property day to day.
Even then, you still have to approve major costs and review the numbers regularly to make sure that the asset stays on track.
Another downside is that you can’t sell a commercial property as quickly as a public REIT share.
It can take months (even years) to sell a commercial building.
Transaction costs will inevitably eat into returns, too.
What about private equity real estate?
REITs and direct ownership are not the only ways to invest in commercial real estate.
Some investors also consider private equity real estate funds or deal-specific private investments.
Private equity real estate can give you access to professionally managed commercial assets outside the public market.
You may be able to choose a specific deal rather than buy into a broad portfolio in some cases.
You get much more visibility into the asset than you would in a REIT, without having to manage the property directly.
However, many of these funds only accept accredited investors: Under current SEC rules, individuals can only qualify if their income exceeds $200,000 individually or if their joint income with a spouse or spousal equivalent exceeds $300,000 in each of the two most recent years, with a reasonable expectation of reaching the same level in the current year.
You may also qualify if your net worth is over $1 million, excluding your primary residence.
Note that your money can also stay tied up for years because private equity real estate does not trade on a public exchange.
Depending on the fund terms, you may need to wait until the fund sells the property or allows investors to redeem their interests.
