REITs Vs. Private Market Real Estate: Which Provides Greater Returns

The housing sector soared to new heights in 2023, as median home prices hit an all-time high of $389,800 last year. Despite the skyrocketing mortgage rates, housing demand remained robust in 2023, making the real estate sector one of the best-performing alternative investment markets.

This trend will likely continue in 2024 as mortgage rates are expected to decline, as the Federal Reserve is poised to lower the benchmark interest rates in the upcoming months.

"Comerica forecasts that national house prices will rise 2.9% in 2024," Bill Adams, chief economist at Comerica Bank, said.

While real estate investment trusts (REITs) are typically preferred by investors seeking to diversify their portfolios to include real estate and generate passive income, the private real estate market is also a rewarding alternative. 

Understanding REITs

REITs are investment vehicles that own, operate or finance income-generating real estate across various sectors, such as residential, commercial and industrial. Traded on stock exchanges, one of the key advantages of REITs is their ability to provide liquidity and diversification to investors, allowing them to gain exposure to real estate without the need for direct property ownership. REITs distribute at least 90% of their taxable income to shareholders through dividends.

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Publicly traded REITs in the U.S. own approximately $2.5 trillion in total assets, spread across 575,000 properties and 15 million acres of timberland. Over the past 25 years, the total return performance of REITs has surpassed that of the S&P 500 Index and other significant indices as well as outpaced the rate of inflation. FTSE Nareit all equity REITs have delivered 8.62% in annualized returns over this period, while the Russell 1000 large-cap stocks generated 8.08% returns.

Superior Returns: Private Market Real Estate

In contrast to REITs, private market real estate funds are not actively traded on stock exchanges. Financial institutions, hedge funds and other endowment funds typically invest in private market real estate funds. Approximately 92% of the total U.S. commercial real estate market, which is valued at $21 trillion, is privately owned, while 8% is publicly owned.

Private equity real estate funds are generally actively managed and provide investors with more control over property selection, management and potential value-add strategies. 

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Several crowdfunding platforms are gradually making the private equity real estate sector accessible to retail investors, compensating for the additional associated risks with significantly higher returns.  

Private market real estate has the potential to deliver substantial returns, especially when successful property management and value enhancement strategies are employed. Additionally, the illiquid nature of private market real estate can be advantageous in times of market instability, as it may shield investors from short-term market fluctuations.

CrowdStreet, which was named the best overall real estate crowdfunding site for three consecutive years, reported a realized internal rate of return of 17.9% with a median hold period of 3.1 years. RealtyMogul, on the other hand, has an overall realized IRR of 20.8%, as of Dec. 31. 

Risks In Private Market Real Estate

Liquidity risk is a critical consideration in the private equity real estate sector. Unlike publicly traded assets, these real estate investments are often illiquid and are subject to a lock-up period, meaning that it may take time to sell or exit an investment. 

The lack of liquidity can pose challenges, especially during economic downturns when investors may face difficulties divesting their assets quickly. Private equity real estate investments don't have regulations regarding dividend distribution, with most payouts arising from capital gains from selling an investment property. 

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