Debt vs. Equity, Part Two: Private Debt Funds, REITs and TICs
In our last blog, we focused on a working explanation of debt investments vs. equity investments. Today, we’ll discuss examples of both, including private real estate debt funds, REITs, and TICs. With payouts from these three investments totaling over $100 billion annually, they’re worth knowing about!
TIC: Tenants in Common
Tenants in common own an interest in a specific property, and this stake typically entitles them to periodic use of said property. This sounds similar to a timeshare setup, but in the case of a TIC arrangement, you are more likely be one of a limited number of stakeholders. The property can be leased to non-stakeholders as well, thereby generating income. An example of this might be a resort or a multi-use high rise that includes both residential and commercial space.
TICs are sometimes touted as shelters from capital gains tax, since federal regulations allow capital gains to be deferred if the proceeds from the sale of an investment property are rolled over into the purchase of new property within 45 days. This is known as a 1031 exchange. Keep in mind, though, that the intention in the case of a 1031 exchange is typically to make a long-term investment in a specific property.
Upfront fees tend to be quite high for TIC investments, topping out at 22%. One can see how these high fees might offset the benefit of any deferred taxes! TICs can also end up being a “too many cooks in the kitchen” scenario, with multiple investors struggling to come to a consensus on important operational concerns.
REIT: Real Estate Investment Trust
REIT investors are fundamentally equity stakeholders in a company that manages multiple real estate investments, usually commercial real estate. In this sense, it’s the closest equity-based parallel to a private lending debt fund. Some REITs are publicly traded and subject to SEC regulations. Others are private. Private or public, REITs have a big impact on the US real estate market, and 40,000 commercial real estate properties are owned by REITs.
Likewise, the real estate market has a big impact on the returns from REITs. In general, REITs have a good long term return. From 1975-2014, REITs had an average annualized return of 14.1%. Short term returns can be a different matter. The Dow Jones Wilshire REIT Index was hit especially hard in 2007-2008, losing half of its value in two years.
It’s best to think of REITs like specialized mutual funds where you own real estate instead of stocks. And like many mutual funds, which purport to be focused on the long term, this means you are largely left to the whims and volatility of the market.
Private Lending Debt Funds
Private lending funds like Aloha’s offer financing to borrowers who are investing in and rehabbing real estate, as opposed to actually acquiring properties themselves like TICs and REITs. Lending is based on a LTV ratio of the After Repair Value of the property, and loans require renovation plans, with rehab draws being disbursed in stages. It’s possible to use a private lender to do a 1031 exchange, interestingly, but a debt fund is generally not focused on long-term loans. The point of a private lending debt fund is to provide attractive yields to investors who like passive income. They offer a relatively high ROI, and are quite liquid for real estate investments, since loan terms expire so quickly. Private lending can be less vulnerable to market fluctuations, due to its level of liquidity through portfolio turnover, and overall approach of being positioned short-term, versus owning real estate for the long term. We also use no leverage, whereas owners typically do.
Your investment choices will depend on your goals. And if you’re seeking a defensive, debt-based, income-generating investment, we’d appreciate a further look.