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October 31, 2018

Q & A About Real Estate Investment Trusts

QUESTION: My husband is a broker, and I am a REALTOR. We are very interested in more information about REITs (Real Estate Investment Trusts). There is an attorney my husband is speaking with about this, but we also want to get a further education through you if possible. Are there any specific seminars you hold in regards to this? If not maybe you can refer me to someone I can network with. Your help is greatly appreciated.

A REIT is a sophisticated "group investment." Group investments can have different legal structures, benefits, and consequences.

There was a time in my real estate career when I was involved with investment groups or what we called "real estate syndications." I participated as a consultant to limited and general partnerships, broker to partnerships, and as both a limited and general partner in some real estate partnerships. I currently continue to be involved in a general partnership I have been involved in for 27 years (with my real estate brokerage partner and two high school friends). The assets of the partnership are a five-bay coin-operated carwash and two adjacent parcels (single-family homes). This general partnership has a formal partnership document created by an attorney specialist and is successful because the investments are sound and the partners have trust and respect for one another, not to mention a long history as close friends. General partnerships are not suitable for everyone.

There are no seminars that I know of on the subject today that I would recommend. There were years ago, especially as real estate investing benefits were amplified by the Economic Recovery Tax Act (ERTA) in 1981.

There were also books on the "whys and how-tos." In the early 1980s, I worked with and attended seminars with an attorney, author, seminar promoter and syndicator named Mark Long. Mark wrote "Big Money Brokerage, Volumes I and II." It is out of print, but the Google search engine found a decent "primer" on the subject.

Each investment group provides opportunities to acquire properties that the individuals would not have the ability to purchase on their own. Tax law and the "active participation rule" limit some of the immediate tax benefits that were available to investors of 20 years ago. That being said, getting groups together to invest in real estate can still be a great career path for competent real estate professionals.

There are different investment group structures.

1. Partnerships - Tax consequences are passed through to partners and taxed at the partner's tax rates. There are General Partnerships and Limited Partnerships.

A. General partnerships - All the general partners have unlimited liability (Joint and Several Liability), and because all general partners participate in the management of the partnership and its assets, General Partnerships can be difficult to manage.

B. Limited partnerships - Have two classes of partners, General Partners, and Limited Partners. All General partners are responsible for the management and control of the partnership and its assets and have unlimited liability.

Limited partners liability is limited to their investment, and they have no control over the partnership or its assets. There are two types of limited partnerships, Private Placements, and Public Placements.
1. Private Placements are the least regulated of the two and have the lowest legal and compliance requirements and consequently, the lowest legal fees and costs to put together. When creating a limited partnership, there are limits on the total number of "unqualified investors."The marketing of the investment opportunity must be private, and to people you know or with whom you have a pre-existing relationship. There are "specified offerings" and "blind pool offerings." With specified offerings, the general partners acquire property or the rights to property and then market the interests in the partnership with the property and its specifics outlined in the prospectus. With Blind pools, the general partners may create a profile of the property type they intend to acquire and investors invest without knowing the ultimate property to be owned.

2. Public Placements require more legal, registration, compliance and disclosure (and expense) but the offering can then be made to the "public," making it easier to raise more money from more investors (not limited to the number or type of investors).

1. Real Estate Investment Trusts (REITs) - A REIT is a corporation (lots of legal, compliance and disclosure requirements and expense) which must invest its assets in real estate and has the liability characteristics of a corporation limited liability of all investors, and tax consequences are "passed through" as they are in partnerships. Partners can offer their shares for sale to other investors and REITs are typically more liquid than partnership investments.

2. Limited Liability Companies - Specific to the laws of your state similar to a corporation investing, which limits the liability of all investors.

3. Joint Ownership (Usually Tenant in Common Ownership) - This is where several parties might own a real property asset as Tenants in Common. This is sometimes done informally, with the deed being the only document indicating a "partnership exists." Make sure you have an attorney create some "landholding agreement" which stipulates what happens "if," if a partner wants out if a partner dies, etc.
When should you use one of the above over the other? One rule of thumb could be the amount of money you plan to raise. I would say REITs are in the 100 Million Dollar range, Public Placements in the multi-million dollar range, and Private Placements in the multi-hundred thousand dollar range.

When you take other people's money and make investments for which they have no management control, you are more than likely dealing with a "security" and securities laws come into play. Be very careful and engage the services of a good attorney who knows these things. Investor communication and management are very important, as is managing the expectations of the investors.

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