Real Estate Investment Trust (REIT)
A REIT focuses on investing in income-producing real estate (i.e. core and core plus properties) and generally focuses on one type of asset class. You can think of a REIT as a real estate mutual fund. Investors in a REIT are looking for a diverse portfolio, a steady, increasing dividend and long-term capital appreciation. What makes a REITs special is they do not pay taxes. However, to get this special tax treatment, they typically pay out most of their taxable income as dividends to shareholders.
There are two types of REITs: public and private, the most common of which is public. Public REITs are traded on the major stock exchanges and investors can buy and sell shares as they would any other stock. Public REITs raise capital for acquisitions by selling shares to the public. Private REITs generally raise capital through the private market and investments are sometimes limited to accredited investors. When a REIT acquires a building, they will use approximately 40%-50% leverage so as to maintain a less risky investment profile.
Real Estate Private Equity (REPE)
REPE funds focus on value-add real estate opportunities in order to achieve outsized returns. REPE funds are looking for annual returns of 15%+. As a result, the fund focuses almost exclusively on value-add and some opportunistic opportunities. Additionally, in order to achieve those returns, a typical deal will have 60%-80% leverage in order to juice the returns. However, this also adds significant risk to the profile.
Capital to fund acquisitions is raised in the private market. The biggest investors in an REPE fund are asset managers looking for a way boost their portfolio's return. REPE firms will typically raise a fund, invest in the real estate, stabilize the properties, and sell the portfolio to core or core plus investor.
A development company is the riskiest real estate investor but can also achieve the highest returns. Although some new developments are build-to-suits (i.e. a company has already committed to leasing the property prior to building it), most new developments are speculative (i.e. "if we build it, they will come.")
For a new development, a developer will typically contribute 10% of the capital stack, an outside investor will contribute 15%-30%, and the remainder will some combination of debt (senior + mezzanine). If the project goes sideways, the lender gets their money first, the mezzanine lender second, and any remaining money goes to the developer and investors.
Developers face the risk of spending millions of dollars developing a property and then having that property sit vacant which means they cannot realize the value of it through a sale. As you can imagine, a small change in a market can crush a developer.
Large asset managers, such as banks and insurance companies, are looking for a way to earn a higher yield than the treasury but in a relatively safe manner. As a result, asset managers will invest almost exclusively in core and core plus properties to ensure safety of capital. Money comes directly from their own balance sheet and they will usually use little, if any, debt on a deal.
Check out our Real Estate Career Guide for even more information on the different types of real estate investors!