REOCs vs REITs: What Real Estate Investors Should Know

Real estate investing goes beyond buying property. One powerful option is Real Estate Operating Companies (REOCs). REOCs are publicly traded companies that invest in and manage commercial real estate such as offices, hotels, retail spaces, and multifamily buildings. Unlike REITs, REOCs reinvest profits back into the business, focusing on long-term growth rather than regular dividend payouts.

Key difference:
• REOCs: Growth-driven, flexible strategy, higher corporate taxes
• REITs: Income-focused, must distribute 90% of earnings, tax-efficient

Bottom line:
REOCs suit investors seeking capital appreciation, while REITs appeal to those prioritizing stable income. Choosing the right structure depends on your investment goals and risk appetite.

What Is a Real Estate Operating Company (REOC)?  

A real estate operating company (REOC) is a publicly-traded company that actively invests in properties, generally commercial real estate. Unlike real estate investment trusts (REITs), REOCs reinvest the money they earn back into their business and are subject to higher corporate taxes than REITs. They include various types of real estate holdings and carry potential risks.

KEY TAKEAWAYS  

• A REOC is a publicly-traded company that invests in real estate and reinvests profits back into the business.

• Unlike REITs, REOCs are not required to distribute earnings to shareholders, allowing for growth through reinvestment.

• REOCs generally invest in commercial properties like retail stores, hotels, and office buildings.

• Investors buy REOC shares through traditional brokers, gaining exposure to diverse real estate portfolios.

• REOCs face market risks, including interest rate volatility and housing market risks.

How REOCs Enhance Real Estate Investment Portfolios  

Investors can diversify by adding real estate to their portfolios. Purchasing real property is one option, but that can come at a big cost and immense risk. Investors who buy properties—residential and/or commercial real estate must be able to bear the financial burden of purchasing and maintaining properties in addition to the risks and uncertainties that come with the housing market.

REOCs can shield investors from some of the risks that come with holding real property. Owning REOC shares gives you immediate exposure to various real estate types managed by experts. They mainly hold commercial properties like retail stores, hotels, office buildings, malls, and multifamily homes. Many REOCs also invest in and manage properties. For instance, a company may sell or lease out units of a multifamily home or office building to different people but still maintain and earn money from common spaces such as parking lots and lobbies.

REOC shares trade on exchanges like other public companies. Investors can purchase shares through their broker-dealer or another financial professional. Although they eliminate the risk of holding physical property, REOCs remove the risk of holding physical property but still face market risks like interest, housing, liquidity, and credit risk.

Comparing REOCs and REITs: Key Differences and Benefits  

While both invest in real estate, REOCs and REITs differ in function and strategy. REITs own and operate properties that generate income through rents or leases. These may be residential dwellings, hotels, and even infrastructure properties such as pipelines and cell phone towers. Investors can choose to buy shares in three different types of REITs equity REITs, mortgage REITs, and hybrid REITs. REOCs are structured in a way that allows them to reinvest their earnings back into the company rather than distribute them to shareholders. As such, they can expand their holdings by purchasing new properties or put money back into existing holdings to improve them. They may also use earnings to buy new properties for the express purpose to sell them back at a later date. Because REOCs reinvest earnings, they don't receive tax breaks and pay higher taxes than REITs.

In order to qualify as a REIT, companies must meet certain requirements. These include among others investing a minimum of 75% of their assets in real estate and distributing at least 90% of their earnings to unitholders. In exchange, REITs get favorable tax treatment. Corporate taxes for REITs are far lower than those imposed on REOCs because they are exempt from federal taxation. Due to their special tax status, REITs buy properties with limited risk. Their investment strategies tend to be for the long term. This means REITs don't purchase investment properties in order to sell them in the future the same way some REOCs do.

The Bottom Line  

REOCs are publicly-traded companies that engage in real estate investments. They include some benefits for investors, such as immediate exposure to diverse real estate assets without the risks of holding physical property directly. REOCs can reinvest their earnings into the business, allowing for potential growth and expansion, unlike REITs which are required to pay out most of their earnings. They face higher corporate taxes compared to REITs, however, and there are associated market risks.

Investors should consider their investment goals and risk tolerance when choosing between investing in REOCs or REITs.

Resources  

U.S. Securities and Exchange Commission (SEC) – REIT structure & public company filings

Internal Revenue Service (IRS) – REIT tax rules and distribution requirements

Nareit (National Association of Real Estate Investment Trusts) – REIT vs operating companies

Morningstar – Public real estate company analysis

Bloomberg – Publicly traded real estate operating companies

CFI (Corporate Finance Institute) – REIT and real estate investment structures

Wall Street Journal – Commercial real estate and public real estate firms

Harvard Business Review – Real estate investment strategies