Question

Elaborate on the benefits and weaknesses of internal and external management of REITs and REIT mutual funds.

Answer 1

REITs stands for a real estate investment trust (REIT) is a company that owns, and in most cases operates, income-producing real estate.

Internally managed REITs

Benefits

1. The REIT manages its own portfolio, rather than outsourcing that task to an external management team.

2.They can concentrate on their own portfolio.

Disadvantages

1.The shift from external management to internal management wasn't without sacrifice

2.Externally managed funds tended to have lower administrative costs than those managed internally.

3.External managers are also more likely to have the scale to support larger and more-capable teams of investment and support professionals.

Externally managed REITs

Benefits

1. Capitalizing on market opportunity — with an existing platform in place, managers can launch REIT products in response to evolving market trends. An external manager can offer resources, talent (personnel) and influence that an internally managed REIT may not be able to rival due to the scale of the external advisor.

2.An external manager brings these benefits on day 1 and can draft additional skills and/or resources from across the parent platform as and when they are needed.

3.For an industry built around individual transactions and assets, access to best-in-class talent is critical.

4.For new and/or smaller REIT vehicles, this can be a differentiating feature that enables a new REIT to establish itself more rapidly

Disadvantages

1.Performance hurdles may encourage managers to use excessive leverage and take undue risk.

2.Externally managed reits have often been high-load products, particularly in comparison with their internally managed peers, where annual overhead is typically less than 50 basis points (bps) of total assets. Management fees on externally managed vehicles are typically in excess of 100bps of net asset value, and fee structures may include sales commissions and dealer manager fees, as well as acquisition and investment fees.

3.Fee incentives often challenge manager/shareholder alignment either through incentivizing transactions or by encouraging managers to raise capital and grow the size of the business in order to receive higher management fees at the expense of performance and/or shareholder dilution.

REIT MUTUAL FUNDS

Advantages

• Mutual funds are managed by experienced professionals who are equipped with the skills to plan or strategise the investments. Likewise, Real estate mutual fund schemes are also controlled by qualified professionals. Ample research is executed to ensure the safety of the resources of investors.
• During the time of inflation, the prices and rents of the properties increase which can also bring a rise in the value of real estate making it a protected investment in downfalls.
• The investors of REMF are given the choice of investing after keeping their financial goals and incomes in mind. This factor makes these type of mutual funds a flexible option for investing.

Disadvantages

There is no instrument which is entirely safe

• Investing into REMFs might cause an inclination towards different risks for the investors. It is recorded that the rise in interest rates cause an eventual fluctuation in the returns of the real estate mutual funds.
• Also, REMF is a sectoral fund and sectoral funds are directly affected by the changes in the market performance which implies that the performance of real estate funds will prosper only when the real estate market is flourishing. And the entire real estate fund sector will be affected by any drop in the same market.