REIT vs REOC

These are firms that purchase, develop, and manage real estate.

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.

Hilton Hotels Corporation (NYSE: HLT) was the first REOC formed in the U.S. in 1947; therefore, they were introduced much earlier than REITs in the United States.

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 are not required 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.

Real Estate Investment Trusts Examples

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

Here are some examples of these firms:

Real estate Operating Companies Examples

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

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

What are the differences between REITs and REOCs?

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 TrustsReal 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, clear relation to real estate should be apparent.
Must pay out 90% of taxable income as distributions/dividendsDividend payouts subject to management discretion
No double taxation due to special tax reforms in the U.S for real estate trustsInvestment 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. TreasuriesNo requirement on asset management
Have no more than 50% of its shares held by five or fewer individualsNo requirement on shareholder distribution
Have 100 shareholders after the first year of operations to continue to remain as a trustNo such requirement to continue operations

The table highlights that there are much more heavy Real Estate Investment Trust regulations than REOCs. Therefore, giving these firms much more flexibility in their operations. 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.

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.

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. Unsurprisingly, this makes dividends from REOCs unattractive when compared to REITs.

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

Investors should be aware of the many drawbacks that exist when investing in real estate firms of both kinds. Although both sets of companies have performed well over the long term, with REITs, in particular, outperforming the market, there are still some considerations to know when investing in these assets.

Both publicly-traded kinds of real estate firms provide investors with similar advantages that stand out. For example

  • Accessibility to real estate
  • Convenience when trading stock
  • Assets managed by an experienced management
  • Ability to diversify
  • Steady capital appreciation

A key disadvantage for a real estate trust is that management fees are associated with them; these cut away from returns as real estate requires management oversight to ensure that the development and operation of income-producing assets are executed well.

However, there are specific pros and cons to both types of investments. For instance, regulations ensure that real estate trusts provide consistent distributions to shareholders; this is usually not the case with real estate operating firms.

In addition, such regulations on distributions also mean that real estate trusts have little capital to reinvest into the firm; therefore, operating firms have much more potential capital appreciation as they do not make as many distributions.

Moreover, regulations on real estate trusts mean that real estate operating firms have much more flexibility in their asset management and investment decisions than Real Estate Investment Trusts.

Further, real estate operating companies are also permitted to have business interests outside the real estate industry.

Additionally, tax laws favor the distributions made by Real Estate Investment Trusts to investors as there is no double taxation. Conversely, this is not the case with dividends distributed by real estate operating companies.

The elements associated with Real Estate Investment Trusts and REOCs are different; nevertheless, it is difficult to judge if such factors should be attributed as benefits and limitations as a generalization.

This is because these factors may be viewed positively or negatively based on an investor's goals and risk tolerance.

For that reason, an investor should consider the goals of his/her portfolio and then judge which type of firms fit well in that landscape. 

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 periodS&P 500 (total annual return)FTSE NAREIT all equity REITS (total annual return)
1972-201912.1%13.3%
The last 25 years11.9%12.6%
The last 20 years7.7%13.3%
The last 10 years14.2%13.2%
The last 5 years12.5%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 that real estate trusts have gained over the past two decades is due to a track record of market-beating performance; REOCs has yet to be seen as the more attractive investment option comparatively.

Even so, many REOCs have stood out as attractive investments due to their significant returns.

To summarize, 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 in returns for most individuals; this is especially true considering their current income.

Hence, as of today, Real Estate Investment Trusts are much more popular as they are well-positioned in this market. Further, it is simple to identify these companies over REOCs which do not have set standards. Therefore, it is pretty tough to recommend one over the other.

Investing in a real estate trust or a real estate operating company depends on the type of investor making the query. This entails their personal experience, goals, and risk tolerance. 

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Research and authored by Imran Husain l Linkedin

Reviewed and Edited by Aditya Salunke I LinkedIn

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