Buying an individual property provides much higher return than buying a comparable REIT. The key — bargain!

Say you have 300k to invest, either in a property or in a simple property-holding REIT without any value enhancement.

• if you are inexperienced, I think the REIT is safer due to liquidity, diversification etc. You may earn $15k/Y or 5% in dividend.
• if you are experienced, you can spot bargains and get good rental yield and/or appreciation. You could earn 24k/Y or 8% in NRY + 200K~600k capital gain. You won’t get the same from the REIT. In fact the REIT company boss is another experienced investor. She spots bargains, which generate outsize returns, but she won’t pass on all the profits to you in the form of REIT dividends. She would keep most of the profit as her own profit !

In fact, this is similar to Macquarie MIRA fund (or AsiaProperties or a hedge fund) spotting bargains and passing on a small part of the profit to investors. A decent hedge fund typically passes on a good portion to investors to make 6% return in a reasonable year. Clearly the fund itself makes a lot more profit.

Bargain picking is high-risk-high-return game These fund managers risk OPM (optionally with some house money at, say, 22% of the total) but cut a disproportionate share of the return, much higher than the 22%. In other words, investors take on all the risk, but receive part of the return.

Debt — is another Fundamental difference. Debt is frequently used by REIT operators, as a double-edge sword. Though it can enhance return (possibly the dividend yield), I generally avoid debts in my own property investments because the mortgage interest can erode my rental income.

The above probably describes the Singapore REITs. Now let’s look at the more advanced REITs, highly “visible” in the U.S. I can see this process in Energy12, AsiaProperties and MIRA (Macqurie Infrastructure and Real Asset).  These deal makers can create huge value on the real estate bargain assets they buy. They enhance the assets and generate large profits, but again, the few individuals (deal makers) involved invariably keep a disproportionate share of the profit.

— In all REITs, the apportionment of profit includes “sweat equity”.
Say deal makers put in $12M, and REIT investors put in $88M. Out of the gross profit, deal maker first takes 50% as compensation. The remaining “net profit” is split 12:88 based on investment amount or outstanding shares. Effectively, the sweat equity is equivalent to $100M of capital.

REIT investors receive 88% of the net profits i.e. 44% of gross profit, which could translate to a 10.3% annualized return, beating the benchmark.

Suppose you as a REIT investor complains about the 50/50 split. Deal maker could say “If investors don’t rely on my bargain hunting skill, then they get none of this return. Investors could choose not to invest with me. It was investors’ choice .. take it or leave it. If you think you can get bargains yourself, then you can run your own REIT.”