Question

1. Consider the left (equity or ownership) side of the “Real Estate Example of the Investment System”. Explain what investors are gaining and what they are losing in terms of investment attributes as they move from owning the underlying asset, to owning limited partnership units, to owning shares in a publicly traded REIT that owns the underlying asset. What are the trade offs? Cite cross references.

Answer 1

In a real estate when you move from owning a property to owning stake in a partnership to owning stake in REIT. REIT is also known as real estate investment trust. When you own a real estate, you own that property and that property is your equity (as long as there is no debt due on that), so owning a property is like you own the building, you can modify it according to your needs and if you find appropriate buyer with attractive price offer you can sell the property and have gain on that. The drawback of owning a real estate property is its maintenance cost and taxes which can be huge. Here the risk is high but the reward is also high if the price goes up. When you move into a limited partnership then you yourself don’t own the real estate property but you own stake in a partnership company which does the business in that area so you indirectly own it. The benefit of this structure is that you do not have to incur the maintenance cost of the building and that will be taken care and you have to pay a certain portion of the cost. The disadvantage is that you do not have control and the decisions being taken has to be taken with consultation with other partners. When you buy units in the REIT, then it is similar to buying share of companies in the case of REIT, the company is in the business of operating and buying and selling real estate so you buy shares of the REIT and when REIT makes profit you receive it the form of dividends. For REITS it is mandatory for them to distribute a major part of their profits. The benefit is that you get stable income and as REIT share value grows you also have capital gain but you do not have any control on the property since the number of shareholders are large in REIT so one shareholder can not impact the business direction.