REIT vs REOC

Learn about the different types of real estate companies

What is REIT vs REOC?

As an investor, it is important to know the differences between REIT vs REOC. A real estate investment trust (REIT) and a real estate operating company (REOC) are types of real estate companies that trade in a public exchange market but come with functional and operating differences. A REIT is a real estate company that allows investors to buy shares in the company and benefit from dividend distribution at the end of the quarter or year.

 

REIT vs REOC

 

REITs invest in different types of real estate properties such as residential apartments, office complexes, warehouses, shopping malls, etc. REOCs, on the other hand, allow investors to buy shares of the company and reinvest incomes in new constructions and acquisitions rather than distribute the entire income to shareholders. Also, REOCs tend to be more flexible than REITs in the projects they can undertake.

 

 

Summary

  • REITs and REOCs are types of real estate companies that trade in the public exchange market.
  • A REIT owns and manages different types of real estate properties such as office buildings, hotels, and shopping malls that must meet various regulatory requirements to maintain their REIT status.
  • REOCs provide greater flexibility than REITs. They can reinvest a majority of their earnings into new constructions, acquisitions, and redesigning properties for sale.

 

Understanding REITs

A REIT is a real estate company that owns and manages real estate properties that are spread across a range of sectors. Most REITs focus their energy and attention on a specific sector. However, there are REITs that diversify their investments by investing in multiple sectors, so they hold different types of real estate properties in their portfolio.

REITs make money by leasing and renting space in properties under their portfolio. They also earn additional income by selling some of the properties, as well as earning interest from mortgage financing the properties.

To maintain their REIT status, REITs are required to meet various requirements that include:

  • A minimum of 100 shareholders
  • No five shareholders can hold more than 50% of the total number of shares.
  • Seventy-five percent (75%) of the gross income should come from real estate investments.
  • The company should distribute at least 90% of the annual net income.
  • Invest at least 75% of incomes in real estate, US Treasuries, or cash.

 

REITs that meet these requirements maintain the REIT status and are exempted from paying standard corporate taxes on their gross income. Instead, at least 90% of their taxable income is distributed to shareholders as dividends. The shareholders must then declare these dividends when filing the taxes with the Internal Revenue Service (IRS).

 

Understanding REOCs

A real estate operating company (REOC) owns and manages real estate properties in multiple sectors. They allow shareholders to buy and sell shares of the company in a public exchange market. They operate in the same way as REITs, but they enjoy greater flexibility in the type of properties that they can invest in.

REOCs are not subjected to the same operating requirements that REITs must meet to retain their status. For example, REOCs are not mandated to distribute their net income to shareholders. They can also reinvest the net incomes earned from business operations into new acquisitions or renovating old properties for resale.

Another advantage that REOCs enjoy over REITs is the flexibility to make developments and capital improvements on land that they own. They can acquire existing properties, redesign the features, or refurbish the fixtures and fittings, then sell the properties for a price that’s higher than what they originally paid. They can also finance new projects and sell the units as residential houses, offices, or warehouses.

The REOC retains control of the common areas such as the parking bay, electricity, water, conference halls, corridors cleaning, etc. and charge a monthly fee to the companies or residents. However, REOCs must pay standard corporate taxes that REITs are exempted from paying.

 

REIT vs REOC: How Do They Compare?

REITs and REOCs share a lot of similarities in the way they operate and the investments they make. However, the types of entities come with certain functional and strategy differences that distinguish them.

 

1. Distribution of Net Profit

One of the main differences between such types of entities is how the net income generated from its key operating activities is used. REITs are required to distribute a majority of the net income as dividends to its shareholders.

Some REITs may choose to distribute 100% of the revenues, but the law requires them to distribute at least 90% of the net incomes as dividends. For REOCs, the management is at liberty to set policies on how the net income is reinvested in new projects or distributed to shareholders.

 

2. Investment Strategy

REOCs are able to fill up their portfolios quickly by using internal funds to invest in new constructions, acquisitions, and redesigning existing properties, then selling them at a profit. They can also serve as a management company that manages properties and collects rent on behalf of other real estate companies.

On the other hand, REITs are required to distribute a majority (at least 90%) of the net income as dividends, which means that they are left with less than 10% of the net profits to reinvest into new projects. Also, selling properties is not part of REITs’ core operations, and may not use such a method to generate revenues. Instead, they must constantly issue new shares to investors to raise capital for investments.

 

Related Readings

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Cap Rate (REIT)
  • Funds Available for Distribution (FAD)
  • Private REITs vs Publicly Traded REITs
  • Risk Factors of Investing in REITs

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