Real Estate Operating Companies (REOCs) Explained: How They Work, Types, and Examples
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Summary:
Real estate operating companies (REOCs) are publicly-traded firms that actively invest in commercial real estate. Unlike real estate investment trusts (REITs), they reinvest their profits back into their business and are subject to higher corporate taxes. This article delves into the world of REOCs, exploring their unique characteristics, potential benefits, and differences from REITs.
What is a real estate operating company (REOC)?
A real estate operating company (REOC) is a publicly-traded firm actively involved in real estate investments, particularly in commercial real estate. Unlike real estate investment trusts (REITs), which distribute earnings to unitholders, REOCs reinvest their profits back into their business. This distinction subjects them to higher corporate taxes than REITs.
Understanding real estate operating companies (REOCs)
When investors seek to diversify their portfolios and include real estate, they have several options. Directly purchasing real property can be expensive and entails significant risks. Property owners must bear the financial burden of acquisition and maintenance, along with the uncertainties of the housing market.
REOCs provide a way to shield investors from some of the risks associated with physical real estate ownership. Investing in shares of these companies offers immediate exposure to a diverse array of real estate types, carefully selected and managed by expert teams.
Typically, REOCs focus on commercial properties such as retail stores, hotels, office buildings, shopping malls, and multifamily homes. Many also invest in and manage properties. For example, a company might sell or lease individual units of a multifamily home or office building while still generating revenue from common areas like parking lots and lobbies.
Shares in REOCs are publicly traded on exchanges, making them accessible to investors through broker-dealers or financial professionals. While they eliminate the risk of owning physical property, REOCs are not without market-related risks, including interest rate fluctuations, housing market shifts, liquidity concerns, and credit risks.
REOCs and taxation
One of the significant differences between REOCs and REITs lies in their taxation. REOCs are subject to federal taxes because they are not obligated to distribute their earnings to shareholders. This lack of distribution means they have the flexibility to reinvest their earnings in various ways, such as acquiring new properties or improving existing ones. It also enables them to purchase properties with the intention of selling them at a later date. However, this flexibility comes at a cost—REOCs pay higher taxes than REITs.
REOCs vs. REITs
Although both REOCs and REITs invest in real estate, there are essential functional and strategic distinctions between the two:
Investment and distribution
REOCs reinvest their earnings back into the company, allowing them to expand their holdings or improve existing properties. In contrast, REITs are required to distribute at least 90% of their earnings to unitholders. This difference in distribution makes REITs eligible for favorable tax treatment, as they are exempt from federal taxation.
Qualification requirements
To qualify as a REIT, a company must meet specific criteria, including investing a minimum of 75% of their assets in real estate. REOCs do not have these same requirements.
Investment strategies
REITs often focus on long-term investment strategies and do not purchase properties with the intent to sell them in the future, unlike some REOCs.
REITs tend to invest in properties that mitigate risks associated with certain commercial properties, primarily because of the special tax status they enjoy. Their investment strategies typically involve holding properties for the long term rather than purchasing them for resale, as some REOCs do.
Frequently asked questions
What types of properties do REOCs typically invest in?
REOCs predominantly invest in commercial properties, including retail stores, hotels, office buildings, shopping malls, and multifamily homes. Some may also invest in and manage these properties.
How do I invest in REOCs?
Investing in REOCs is similar to investing in other publicly-traded companies. You can purchase shares through a broker-dealer or a financial professional.
What are the tax implications of investing in REOCs?
Investing in REOCs comes with higher corporate taxes because they are not required to distribute their earnings to shareholders. This taxation is different from real estate investment trusts (REITs), which enjoy favorable tax treatment due to their distribution requirements.
How do REOCs differ from traditional real estate investments?
REOCs offer a distinct advantage over direct real estate ownership in terms of diversification and professional management. While traditional real estate investments require hands-on management and come with high upfront costs, REOCs allow investors to access a portfolio of properties without the need for direct management. REOCs also provide liquidity, as shares are traded on public exchanges, making it easier to buy or sell compared to physical properties.
What factors should I consider when investing in REOCs?
Investors should consider their investment objectives, risk tolerance, and investment horizon. It’s important to assess the specific REOC’s portfolio, management team, and financial health. Additionally, investors should be aware of market risks, such as interest rate fluctuations and economic conditions, which can impact the performance of REOCs. Due diligence and consultation with a financial advisor are essential before investing in REOCs.
Are REOCs suitable for income-focused investors?
REOCs typically prioritize reinvesting earnings for growth rather than immediate income distribution. While they can provide income through dividends, their focus on expansion means they might not offer as much income as real estate investment trusts (REITs). Income-focused investors may find REITs more appealing due to their higher income distribution requirements.
Key takeaways
- Real estate operating companies (REOCs) actively engage in real estate investments and are publicly traded.
- Unlike real estate investment trusts (REITs), REOCs can reinvest their earnings into the business rather than distributing them to unitholders.
- Investing in REOCs offers the potential for greater growth prospects, but they may not generate as much immediate income as REITs.
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