One of the most important long-term steps for real estate investors is diversifying their portfolios — the act of broadening their exposure to various markets and minimizing risks from underperforming sectors. Plenty of options are available, and one emerging strategy is investing through an umbrella partnership real estate investment trust (UPREIT). In what ways can such an investment vehicle help you improve your overall diversification strategy as an investor?
Realized 1031 shares insights below to help you better understand this powerful tool.
UPREITs are operating partnerships (OP) governed by real estate investment trusts (REITs). These partnerships own income-generating real estate, such as office buildings, multifamily homes, or warehouses. Investors become a part of the UPREIT by contributing their assets in exchange for OP units, which are the economic equivalent of REIT shares.
Also called the 721 exchange, this contribution is tax-deferred since there is no official sale. The delay in capital gains tax payments is the main appeal of UPREITs for investors, and why the operating partnership exists in the first place. However, the UPREIT’s structure creates additional benefits like diversification.
What happens when you put all your eggs in one basket? If the basket falls, all the eggs break. Diversification is important in real estate investing because it’s the main strategy that helps investors avoid too much risk. Concentrating all your capital into one sector — the proverbial basket — makes you vulnerable to any issue the sector is facing. For example, those who had focused on office buildings felt the disruptions of the recent worldwide health crisis, leading to huge losses.
A savvy investor, however, spreads their capital across various real estate sectors and geographic locations. That way, when one industry or niche faces economic volatility, other assets create a cushion to ensure steady cash flow even when some are underperforming.
Diversification can take a long time and a significant amount of capital. However, UPREITs provide a shortcut that lets you access new real estate sectors without a lot of effort.
Here are the different ways UPREIT diversification can manifest.
UPREITs own many properties under their portfolios. A strategic REIT will acquire properties across an array of sectors to ensure maximum diversification. For example, an UPREIT may own multifamily homes, mixed-use buildings, and retail shops. As you enter the UPREIT, you also begin earning income from this diverse portfolio. If one property or sector underperforms, the others can pick up the slack and maintain a steady cash flow or dividend distribution.
There are some UPREITs that concentrate on one sector, such as housing, renewable energies, or logistics. Even so, REITs acquire multiple property types that create similar levels of diversification as more diverse UPREIT portfolios.
UPREITs may also own properties across multiple geographic locations. If one market faces volatility or lowered demand, the UPREIT can still maintain steady cash flow or experience only slightly lower profit margins since assets in other locations are still performing well. Compare this to direct property ownership, where a dip in demand could result in a major increase in vacancy rates, leading to losses.
UPREITs also diversify the management of your portfolio. If you directly own all assets, then the burden of management falls entirely on you, which leaves you with immense pressure to stay on top of things and maintain the profitability of your assets. Entering an UPREIT relieves you of some landlord burdens so you can focus on other assets. With the REIT’s professional management, you reduce operational risk while still being exposed to the real estate sector.
OP units also add diversity to your liquidity options. Directly owned properties can take a long time to sell, and some assets can be locked in holding periods that last decades. OP units can be converted to REIT shares and sold for emergencies or changing lifestyles. This added flexibility makes it easier to access your investment’s value when you need it.
Investing in UPREITs provides diversity that reduces risk and enhances the long-term profitability of your portfolio. As you contribute your property and receive OP units, you access the portfolio of the operating partnership, which has professionally managed properties across various sectors and geographic locations. For those hoping to expand beyond single-property ownership and tap into the stability of diversified real estate portfolios, UPREITs are an excellent solution.
Sources:
https://www.investopedia.com/terms/u/upreit.asp
https://www.hellodata.ai/help-articles/what-is-an-upreit-in-real-estate