Many real estate investment strategies are available to meet various needs, risk profiles, and investment goals. Two common approaches are real estate investment trusts (REITs) and direct participation programs (DPPs). Both strategies allow real estate exposure and potential income generation but have different structures, tax treatment, and risks.
REITs are well-known for their benefits, like liquidity and accessibility but do come with risks. They function similarly to stocks you can trade on major exchanges. On the other hand, DPPs allow you to invest in a property or another asset class directly, but the requirements are higher.
Knowing how these two strategies operate can help determine if these investment types fit into your financial and portfolio strategy.
Real Estate Investment Trusts: Buying and Selling Shares
A REIT is a company that owns, operates, or finances income-generating real estate. Sponsors raise funds by selling REIT shares to investors publicly on stock exchanges or privately through broker-dealers and investment firms.
The REIT manages the properties which generate income. The income, in turn, is distributed to each investor through dividends. Investors can also benefit from hands-off involvement in daily operations while enjoying access to institutional-grade real estate. Publicly traded REITs are also highly liquid.
The downsides include value fluctuations based on market movements and no control over decisions concerning the property. REIT dividends are generally taxed as ordinary income. Property mismanagement and poor decisions could result in real estate depreciation. Additionally, private REITs are typically limited to accredited investors and require a large minimum investment.
Direct Participation Program: A Direct Stake in the Property
DPPs are similar to REITs in that they’re pooled investment vehicles typically set up as limited partnerships (LP) or limited liability companies (LLC). DPP participants receive shares or units in exchange for their investments. Unlike REITs, DPPs allow investors to participate directly in real estate ownership and potential profits. As DPPs are pass-through entities, income, losses, and tax liabilities pass directly to the investor. The structures also have the potential for higher returns than those offered by a REIT.
Because DPPs are pooled investments, average investors with limited capital could participate. Furthermore, investors can deduct depreciation, interest expenses, and operating losses.
There are potential drawbacks to DPPs, however. DPPs can be illiquid, with contracts lasting anywhere between five and ten years. They can also be complex investments subject to significant losses based on the underlying real estate. Similar to REITs, DPP investors don’t have control over management decisions. Poor management decisions from the general partner or principal could lead to project failure and loss of income.
What’s Best for Your Strategy?
REITs and DPPs can offer many benefits. Deciding on which structure is best boils down to your investment goals and risk appetite. REITs provide high liquidity, but returns can fluctuate with market conditions. On the other hand, DPPs offer potential tax advantages and higher income opportunities but lack liquidity and reliance on management decisions.
If you need additional guidance about which strategy works for your situation, schedule a no-obligation consultation with Realized 1031 experts by visiting realized1031.com.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
