Institutional Asset Management – Best Practices: Ownership Stakes

If you have a little money saved up that you would like put towards investment opportunities, sometimes it can be difficult to decide where to invest it. There are all sorts of investment vehicles out there, from stocks to bonds to mutual funds. An increasingly popular investment choice, however, are privately-held real estate investment trusts, or REITs. Not tied to the wild swings of the stock market, private REITs can offer great returns, and more of the profits, or disbursements, go into your pockets.

However, the next question is, how should you choose a private real estate investment trust? Bearing in mind that REITs are basically syndicates that pool resources (in other words, the capital or equity of individual resources) to invest in real estate, and then manage this pooled resource for a fee, naturally taking a look at the fee is probably the first thing you’ll do when making your decision.

However, some syndicates demand an up-front ownership stake of up to 20%, on top of the fees they already collect. Up-front ownership stakes are explained as a risk-management tool for the syndicate managers, but from the point of view of the investor, they don’t really add any value to the REIT itself. And the hallmark of a REIT manager is always adding value to the operation. It’s the only way to increase profits.

The stipulation of an up-front ownership stake above and beyond management fees, besides demonstrating the philosophy of the REIT manager, also may indicate a poorly structured syndicate.

As a private REIT best practice, I would argue that the syndicate management should not demand an automatic 15 or 20 percent ownership stake right at the start. Such an ownership stake takes away the incentive for managers to increase the profitability of the properties owned by the REIT. By settling for a smaller (or, even better, no) ownership stake, managers are challenged to find new ways to increase return on investment through their efforts and their expertise.

The REIT manager’s share in profits is dependent on their own performance.

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