Syndication versus REIT compared

Three different products share one name

When someone says they invest in real estate, they may mean one of three quite different things, and conflating them is the reason this comparison is so often argued badly.

A publicly traded REIT is a listed company whose shares you buy through a broker at a quoted price and can sell the same afternoon. A non-traded REIT is registered with the SEC but does not trade on an exchange, so it is bought through a broker participating in the offering and cannot readily be sold. A private syndication is a partnership formed to buy one asset or a small number of them, sold under an exemption from registration to accredited investors, with no market of any kind.

The SEC draws the first distinction as the important one, saying that whether a REIT is publicly traded "is one of the most important distinctions among the various kinds of REITs," and that "before investing in a REIT, you should understand whether or not it is publicly traded."

Most comparisons on the internet pit a syndication against a listed REIT and quietly borrow the liquidity of the listed vehicle for the middle one. The three-way comparison is more useful, because the middle option is the one most often sold alongside syndications and is in several respects the weakest of the three.

What a REIT is, in law

A REIT is a tax election rather than a business model. Per the instructions to Form 1120-REIT, the entity must be a corporation, trust or association, be managed by trustees or directors, have beneficial ownership evidenced by transferable shares "held by 100 or more persons," and it "cannot be closely held." It must also satisfy gross income and diversification tests under section 856(c).

The defining requirement is distribution. To obtain REIT treatment the deduction for dividends paid must equal or exceed "90% of the REIT's taxable income (excluding the deduction for dividends paid and any net capital gain)." In practice, per the SEC, "most REITS pay out at least 100 percent of their taxable income to their shareholders."

That single rule explains most of how REITs behave. A vehicle that must distribute nearly all its taxable income cannot retain earnings to fund growth, so it returns to the capital markets repeatedly for equity and debt. It also means the entity itself is largely untaxed on distributed income, which is the point of the election.

A private syndication achieves single-level taxation differently, through partnership flow-through, and with none of the 100-holder, diversification or distribution constraints. It can retain cash, it can hold one asset, and it can suspend distributions entirely. Those are freedoms and they are also risks.

Liquidity, and what it is worth

A listed REIT can be sold in seconds. That is a genuine and underrated advantage, and anyone telling you illiquidity is simply a premium to be harvested is selling something.

The cost of that liquidity is that you own a security whose price moves with equity markets. Listed real estate is repriced daily by people reacting to interest rates, fund flows and sentiment, not only to rents collected. Over long periods the price tracks the underlying property economics. Over the periods that test an investor's nerve, it does not.

A private syndication has no price, which cuts both ways. You are not shown a number that tempts you to sell at the bottom, and you also cannot sell at all. Transfers typically require the sponsor's consent, there is no secondary market to speak of, and a stated five to seven year hold can extend. That is set out in liquidity and hold periods.

The honest framing is not that one is liquid and the other pays you for illiquidity. It is that you are choosing between mark-to-market volatility you can exit and mark-to-nothing stability you cannot. Which is worse depends entirely on when you need the money, and that is a fact about you.

The middle option, and the SEC's four warnings

The non-traded REIT is the vehicle most often positioned as combining the best of both, and it is the one the SEC writes about most bluntly. Its guidance names four specific risks, and each is worth reading against the syndication alternative.

Lack of liquidity. "Non-traded REITs are illiquid investments. They generally cannot be sold readily on the open market." So the liquidity advantage of the listed vehicle does not carry over.

Share value transparency. "Non-traded REITs typically do not provide an estimate of their value per share until 18 months after their offering closes. This may be years after you have made your investment." A syndication is at least explicit that there is no price.

Distributions may be paid from offering proceeds and borrowings. This is the most important of the four. "Unlike publicly traded REITs, however, non-traded REITs frequently pay distributions in excess of their funds from operations. To do so, they may use offering proceeds and borrowings. This practice ... reduces the value of the shares and the cash available to the company to purchase additional assets." A yield paid partly from other investors' subscriptions is not a yield in the sense most people understand.

Conflicts of interest. "Non-traded REITs typically have an external manager instead of their own employees ... the REIT may pay the external manager significant fees based on the amount of property acquisitions and assets under management. These fee incentives may not necessarily align with the interests of shareholders." That is the same fee-versus-promote tension that exists in syndications, described by the regulator in almost the same words.

Fees, compared without flattering ourselves

Private syndications are frequently criticized for their fee load, and often fairly. The comparison is only useful if the alternatives are quoted honestly too.

For non-traded REITs the SEC gives a figure: "Non-traded REITs generally have high up-front fees. Sales commissions and upfront offering fees usually total approximately 9 to 10 percent of the investment. These costs lower the value of the investment by a significant amount." Roughly a tenth of the money is consumed before any property is bought.

For listed REITs the transaction cost is a brokerage commission, frequently zero, but the ongoing cost is embedded: the company's general and administrative expense, executive compensation and cost of capital all sit inside the share price. Low visible cost is not the same as low cost, though listed REITs are generally the cheapest of the three on any reasonable measure.

A private syndication charges an acquisition fee, an asset management fee, often a disposition fee, and a promote above a hurdle. Those are real and they should be disclosed in full and compared. Our own are at what we charge and when. What we would not accept is a comparison that quotes a syndication's full stack against a non-traded REIT's headline while ignoring the nine to ten percent the SEC describes.

The tax difference is the real difference

If one structural fact should drive the decision for a taxable investor, it is this one, and it is the one least often discussed.

REIT distributions are taxed unfavorably relative to other equities. Per the SEC, "dividends paid by REITs generally are treated as ordinary income and are not entitled to the reduced tax rates on other types of corporate dividends." You receive a Form 1099-DIV and the income is largely taxed at your marginal rate.

A partnership interest behaves differently. Depreciation, including any accelerated portion from a cost segregation study, flows through to you on a Schedule K-1 and can shelter the cash you receive, so distributions in the early years of a leveraged deal are frequently partly or wholly untaxed as received. The shelter is a deferral rather than a saving, because basis falls and the gain at sale rises, and the detail is in cost segregation and bonus depreciation.

The offsetting cost is complexity and delay. A 1099-DIV arrives in February. A K-1 frequently does not, and can create filing obligations in states you do not live in. That is set out in reading your Schedule K-1.

And the flow-through has a limit worth knowing before it disappoints you. Rental losses are generally passive under IRS Publication 925, so a large first-year loss will not usually reduce tax on your salary. The shelter works against the deal's own income, not against your job.

Information, concentration and what you can actually see

A listed REIT files audited annual and quarterly reports, and you can read every one of them on EDGAR before buying a single share. The SEC notes you can verify the registration of both traded and non-traded REITs there and review their reports and prospectuses. That is a real and often overlooked advantage: the disclosure is standardized, audited, and available to you without asking anyone.

A private syndication offers less standardized information but more specific information. You can know the address, walk the property, read the rent roll and trailing twelve months, see the loan terms, and ask the person making the decisions a direct question. Whether that trade is worth making depends on whether you will actually do the work. An investor who will not read a rent roll is better served by an audited filing.

Concentration runs the same way. A listed REIT holds hundreds of properties across markets and its risk is spread; a single-asset syndication is one property, one submarket, one business plan and one loan. Diversification is a feature of the vehicle rather than a virtue of the manager, and a single asset can be understood in a way a portfolio cannot. The choice between them is discussed in fund versus single asset.

Which suits whom

For an investor who may need the money, who will not read quarterly reports, or who wants real estate exposure as one line in a diversified portfolio, a low-cost listed REIT is a reasonable and defensible answer, and we would rather say so than pretend otherwise.

For an investor with capital that is genuinely long-dated, a marginal tax rate high enough for depreciation to matter, a willingness to do sponsor diligence, and enough other assets that a five to seven year lock-up is not a constraint, a private syndication offers things a listed vehicle cannot: property-level specificity, flow-through depreciation, and a return driven by one business plan rather than by market sentiment.

For the non-traded REIT we struggle to construct the case, and we say that knowing it competes with us. It carries the illiquidity of the private vehicle, an approximately nine to ten percent upfront cost, no share valuation for up to eighteen months after the offering closes, distributions that may be funded from offering proceeds and borrowings, and an external manager paid on acquisitions and assets under management. Those are the SEC's characterizations rather than ours.

The right answer is also rarely exclusive. Holding a listed REIT for liquidity and a syndication for specificity is a coherent position, and the two are exposed to different risks despite owning similar buildings.

Our position

We sponsor private deals, so treat the previous section as an interested party's view and check it against the sources listed below, all of which are the SEC's or the IRS's own.

What we will not tell you is that syndications outperform REITs. Comparing a selected private track record against a public index is not a comparison, because the private figures are unaudited, self-reported, unlisted, survivorship-affected and measured over a different period. Anyone showing you that chart is showing you a selection effect.

What we will tell you is what a specific deal owns, what it owes, what we are paid, what we assumed, and which of those assumptions we are least sure about. If that is worth less to you than daily liquidity and an audited filing, buy the listed vehicle. The framework for deciding is in passive multifamily investing, and what a private placement is and is not is described by the SEC in its material on private placements.

What to compare before choosing

1. Is this vehicle publicly traded, non-traded, or a private partnership interest?
2. What are the total upfront costs as a percentage of my subscription, including any selling commission?
3. Are distributions funded from operations, or may they be paid from offering proceeds or borrowings?
4. When will I first receive an estimated value per share or unit, and how is it determined?
5. Will I receive a Form 1099-DIV or a Schedule K-1, and in which states will I have a filing obligation?
6. Who manages the vehicle, are they employees or an external manager, and how are they paid?

What this is built on

1. Investor.gov, U.S. Securities and Exchange Commission, Real estate investment trusts (REITs)
2. Internal Revenue Service, Instructions for Form 1120-REIT, U.S. Income Tax Return for Real Estate Investment Trusts
3. U.S. Securities and Exchange Commission, EDGAR full text filing search
4. Internal Revenue Service, Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits
5. Internal Revenue Service, Publication 925, Passive Activity and At-Risk Rules
6. Investor.gov, Private placements under Rule 506(b) and 506(c)