Hi all,
I am trying to understand the exact differences between a REOC and a REIT and when we would use one over the other. The curriculum does not go into much detail here.
For example, a Topic Test said:
Real estate operating companies (REOCs) generate cash inflows primarily from the sale of developed or improved properties, as opposed to recurring lease or rental income.
Does anyone have a breakdown of the differences?
Thanks,
Rex
REIT is about the property. You, as a REITholder, technically own a portion of a property or a portfolio of properties included in the REIT. REIT is also highly regulated, usually they are obliged to distribute most of their earnings to REITholders. This is why they offer high yield and always issue new units due to having very little retained earnings when there’s an opportunity. REIT also mostly only applies to income-generating properties (aka rentals) so sale of properties/assets is not a part of REIT’s core operations.
Advantages: -Recurring and relatively stable income from leases/rents
-High yields due to regulation
-Lower taxes due to taxation preferences (usually REIT distributions are taxed at a lower rate)
-In some markets, REITs are much more liquid compared to REOC (according to a Topic Test: REITs in US make up of 97% of real estate investments)
REOC is about the company. You, as a shareholder, technically owns a portion of the company like regular companies. One advantage about REOC is that selling primary (newly built) properties is a part of core operation. Selling real estate, if done in hard cash, provides the company with a huge boost in cash flow, compared to rentals/mortgages. Furthermore, REOC adds a huge amount of value if they sell in primary markets (newly built real estate from scratch). In addition, REOC management has their own policies about earnings and distributions so it’s possible to find a high growth REOC if you’re interested in high growth strategies.
Advantages: -High growth strategies with internal funds are possible (due to low dividends, high retained earnings)
-Good sales can provide much higher (albeit less sustainable) return (even better if companies sell properties developed from blocks of land)
REOC is a Real Estate Operating Company , so it does not necessarily buys real estate properties for rental income. They do other things like fund construction projects and then sell the properties (living houses, departments, offices, etc). Also, REOCs can just “operate” or manage properties. For example: Business buildings, corporate buildings, are commonly constructed and sold to companies as offices. Who manage the common areas of the building? The hall service, the parking, corridors cleaning and maintenance, electricity & water, etc. A REOC can operate the building for a monthly fee. Another thing REOCs can do is to buy properties, enhance or redesign their features, and then sell the properties for a higher price.
In the other hand, REITs are Real Estate Investment Trusts. Their core business is to buy & construct buildings for rental purposes. This means, REITs are commonly heavily leveraged because they keep the properties in the trust as assets. REITs issue long-term debt at very low cost. Common investments of REITs are (1) commercial buildings (Malls, shopping centers, boutique stores, street malls, etc); Offices (corporate & business buildings); and (3) Houses and Departments for rental purposes, not for resale.
As you see, they are really different but complementary tho. For example, a REIT can have a chain of Shopping Malls and hire a REOC to manage its properties. However, it is common that REITs have their own management teams, but not always.
Hope this helps.
Thank you Edbert and Harrogath! You are legends!