REIT vs REOC

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Last Updated:January 24, 2024

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What Is REIT Vs REOC?

A Real Estate Investment Trust (REIT) and a Real Estate Operating Company (REOC) are firms that purchase, develop, and manage real estate. However, there are differences in how both types of firms operate and the reasons individuals would invest in them.

Both firms have influenced the development of real estate in the U.S. and other countries in which they have been introduced. Further, they allow investors to diversify their portfolios into several assets.

A critical difference between the firms is that, unlike Real Estate Investment Trusts, Real Estate Operating Companies do not have the same requirement to pay out 90% of their taxable income as distributions; hence, they can reinvest much of the capital generated back into the business for growth.

Therefore, investors typically invest in each type of firm and have different goals and requirements from their portfolios.

Key Takeaways

REITs (Real Estate Investment Trusts) and REOCs (Real Estate Operating Companies) both engage in real estate activities but differ significantly in their operational structures and investor benefits.
One key distinction lies in regulatory requirements. REITs are subject to stringent regulations, including the mandate to distribute 90% of taxable income, while REOCs have more flexibility in reinvesting capital back into the business for growth.
REITs typically focus on passive real estate investments across diverse sectors, offering investors dividends based on rental income and property appreciation. In contrast, REOCs actively own and manage properties, engaging in direct property operations rather than passive investment.
Deciding between REITs and REOCs involves evaluating personal experience, goals, and risk tolerance. While REITs are generally more identifiable and have a well-established market presence, REOCs may attract investors looking for flexibility and potential for higher growth.

What Is REIT?

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-generating real estate across various sectors, such as residential, commercial, or industrial properties.

REITs allow investors to pool resources to invest in a diversified real estate portfolio, receiving dividends based on rental income and property appreciation.

They operate in various subgroups as real estate is diverse with many distinct areas. Therefore, some may wholly specialize in investments in one real estate area. Here are some examples of these firms:

Omega Healthcare Investors Inc (NYSE: OHI) - Healthcare Portfolio
New York City REIT Inc (NYSE: NYC) - Office Portfolio
PREIT (NYSE: PEI) - Retail Portfolio
Xenia Hotels & Resorts Inc (NYSE: XHR) - Lodging/Resort Portfolio
Alexander & Baldwin Inc (NYSE: ALEX) - Diversified Portfolio
EPR Properties (NYSE: EPR) - Specialty Portfolio
MAA (NYSE: MAA) - Residential Portfolio

What Is REOC?

Real Estate Operating Company (REOC) refers to a firm primarily engaged in owning and managing real estate properties for income generation.

Unlike REITs, REOCs may not be structured for special tax considerations and often operate their properties directly rather than through passive investment. They focus on active management and property operations.

Since 1947, many of these firms have formed. Similar to real estate trusts, Real Estate Operating Companies are also involved in several real estate areas. Some examples below

The Howard Hughes Corporation (NYSE: HHC) - Diversified Portfolio
Hilton Hotels Corporation (NYSE: HLT) - Lodging/Resort Portfolio
REOC San Antonio (Private) - Commercial Portfolio

There are private and publicly traded REITs, but there are also public and private REOCs.

REIT vs REOC: How Do They Compare?

Although both are similar in that real estate is a crucial part of their operations, there are distinct characteristics between both types of firms. These differences are mainly derived from the legislative and regulatory requirements that the firms must comply with.

Both types of firms share many characteristics; however, some key differences set these types of firms apart and affect the value these companies provide to investors.

Here is a table below that summarizes the significant requirements that the firms are expected to follow based on their categorization:

Expected Requirements
Real Estate Investment Trusts	Real Estate Operating Companies
Greater than 75% of gross income should come from real estate activities. Further, there are restrictions on asset and development types.	Business interests outside of real estate are permitted. However, a clear relation to real estate should be apparent.
Must pay out 90% of taxable income as distributions/dividends	Dividend payouts have more flexibility and are subject to management discretion
No double taxation due to special tax reforms in the U.S for real estate trusts	Investment is liable to double taxation as the firm is treated as per regular corporation tax laws.
Requires a minimum number of investors to operate and qualify as a trust.	No requirement on a minimum number of investors
Invests at least 75% of total assets in real estate, cash, or U.S. Treasuries	No requirement on asset management
Have no more than 50% of its shares held by five or fewer individuals	No requirement on shareholder distribution
Have 100 shareholders after the first year of operations to continue to remain as a trust	No such requirement to continue operations

Interpretation

The table highlights that Real Estate Investment Trusts (REITs) face heavier regulations than REOCs. However, these regulations come with tax advantages, giving REITs specific benefits.

However, these regulations are a key driver in making real estate trusts attractive to a specific group of investors.

Arguably, the most significant difference between both types of firms is that distributions for Real Estate Operating Companies are at the manager's discretion, while Real Estate Investment Trusts (REITs) have specific distribution requirements to maintain their tax-advantaged status.

Therefore, investors owning publicly traded real estate operating firms such as the Howard Hughes Corporation (NYSE: HHC) should not inherently expect payouts.

This means that Real Estate Operating Companies are treated like any other company since dividend payouts are not guaranteed. But conversely, real estate trusts must meet their distribution requirements to continue operations quarterly.

Such differences imply that real estate operating firms can choose how much capital to reinvest. Therefore, these firms should, in theory, see much more growth as money is used to acquire more assets instead of being distributed to shareholders.

Note

It is important to note that real estate operating firms face double taxation as the net income of the corporation, as well as the distribution made from that capital, is taxed. Therefore, both the investor and corporation face taxation at these levels. However, the double taxation may make dividends from REOCs less attractive compared to REITs, considering the operational flexibility of REOCs.

Real estate trusts provide consistent payouts due to regulatory requirements; thus, many individuals in the Financially Independent Retire Early (FIRE) community and owning retirement-focused portfolios prefer consistent dividend payouts on their capital.

Of course, both publicly traded firms are led by a management structure comprising the board of directors and are responsible for protecting shareholder interest when making decisions. Further, shareholders have the right to vote on company decisions.

Advantages & Disadvantages of REIT and REOC

Investing in real estate involves considerations for both Real Estate Investment Trusts (REITs) and Real Estate Operating Companies (REOCs). Despite their long-term performance, understanding the advantages and disadvantages is crucial for investors.

Some of the advantages of REITs and REOCs are:

Real estate accessibility
Convenient stock trading
Assets managed by experienced management
Ability to diversify
Steady capital appreciation

But, the drawbacks of REITs include:

Management fees reduce returns
Regulations ensure consistent distributions, limiting capital reinvestment
Tax laws favor REIT distributions with no double taxation

The advantages of REOCs are:

More potential for capital appreciation due to fewer distributions
Flexibility in asset management and investments
Permitted business interests outside the real estate industry

Some considerations for Investors are:

Tax laws may favor REITs, but double taxation can be a drawback
REOCs offer flexibility but may lack consistent distributions
Investor goals and risk tolerance should guide the choice between REITs and REOCs

Ultimately, aligning the chosen real estate firm with portfolio objectives is crucial for a successful investment strategy.

Should I invest in REITs or REOCs?

Both types of firms revolve around real estate; however, which company is the better investment?

In terms of performance, Real Estate Investment Trusts has a proven long-term track record. They have outperformed the S&P 500 and private real estate by a significant margin. Here is a table below from the Motley Fool that shows the data:

Total Annual Return
Time period	S&P 500 (total annual return)	FTSE NAREIT all equity REITs (total annual return)
1972-2019	12.1%	13.3%
The last 25 years	11.9%	12.6%
The last 20 years	7.7%	13.3%
The last 10 years	14.2%	13.2%
The last 5 years	12.5%	9%
The last year (2019)	31.5%	28.7%

However, it isn't easy to make the same judgment for all publicly traded REOCs, as categorizing a firm as such is based on the parameters set by an analyst.

Hence, as no set of rules qualifies a firm to be treated as a real estate operating company, there is not much or any data available to create the historical returns of these types of firms.

Further, such companies are permitted to have interests outside real estate; therefore, they have varied returns because of the diverse industries they might be involved in.

The popularity of real estate trusts over the past two decades is due to a track record of market-beating performance; REOCs have yet to be seen as the more attractive investment option.

Even so, many REOCs have stood out as attractive investments due to their significant returns. Both Real Estate Investment Trusts and Real Estate Operating Companies offer attractive returns.

Even so, among the two, Real Estate Investment Trusts stand out as the better investment for most individuals, partly due to their historically strong performance and, in some cases, consistent income distributions.

Hence, as of today, Real Estate Investment Trusts are often more popular, attributed to their historical performance, income distributions, and perceived stability in the market.

Further, while Real Estate Investment Trusts are generally more standardized and identifiable, identifying them is relatively simpler than Real Estate Operating Companies, which may lack uniform criteria for categorization.

Therefore, it is pretty tough to recommend one over the other. Investing in a real estate trust or an operating company depends on the type of investor making the query. This entails their personal experience, goals, and risk tolerance.