REITs have long been a favorite vehicle of Main Street investors looking to invest in the commercial real estate (“CRE”) class without the high capital requirements, learning curve, and headaches involved with investing directly.
For investors interested in the manufactured home/mobile home (“MH”) segment, REITs focused on operating mobile home parks (“MHP”) are a favorite option. For example, Equity Lifestyle Properties (ELS), Sun Communities(SUI), and UMH Properties (UMH)s are three popular MHP REITs, accounting for roughly $25 billion in market value.
While many investors are aware of passive investment opportunities in MHP’s through REITs, few are aware of the opportunities to invest in MHPs in the private markets through equity or debt investments in private funds.
Private investments in MHPs are different from REIT investments in many ways.
The principal difference between REIT and private fund investments is that while REIT investments are completely hands-off – where investors are acquiring stock in companies where they couldn’t name the CEO or other key executives – private funds are more akin to co-investments where investors are acquiring partnership stakes – albeit limited – in companies in which they have the opportunity to communicate with the general partners (GPs) and key executives before making an investment decision.
Here are the major differences between investing in MHPs through REITs vs. through private funds:
The Truth about the 90% Rule
Because REITs are statutorily required to distribute at least 90% of its taxable income to shareholders annually in the form of dividends, investors instantly jump to the conclusion that management must have their best interest in mind. Don’t count on it.
The fine print of the 90% rule says that REITs are required to distribute 90% of “taxable income” not 90% of profits. Therein lies one of the major downsides of REITs.
Taxable income can be eaten away by management fees and salaries before any profits get into investor’s hands and therein lies one of the biggest contrasts between REITs and the private market MHP investments.
With MHP REITs, management gets paid first. With MHP private funds, investors typically get paid first.
One of the glaring problems with MHP REITs is that management is typically compensated based on “assets under management” instead of performance.
When management fees and salaries are directly tied to assets under management, management becomes less concerned with the performance of the REIT and more concerned with “empire building” – attracting investors to grow the size of the assets under management. The bigger the pool of assets under management, the more money management makes.
In that scenario, management will seek to maximize the size of the portfolios under management rather than the performance of the portfolio assets.
Private MHP funds, on the other hand, are structured with investors first in mind. Preferred returns ensure that investors get paid first and that management compensation is directly tied to performance.
An annualized preferred return – of say 8% of investor capital- payable to investors from net profits will motivate management to maximize portfolio performance in order to get paid.
Putting investors first has resulted in higher returns for investors in private markets vs. REITs. Based on the NCREIF (National Council of Real Estate Fiduciaries) Property Index, a reliable measure of private commercial real estate fund performance and the NAREIT (National Association of REITs) All Equity REITs Index, a reliable measure of public REIT performance, private funds delivered an average annual return of 6.6% vs. 5.5% for public REITs over the past 20 years.
Two of the most popular choices for MHP investing are through public REITs and private funds. Investors are attracted to public REITs because of the relatively low barrier to entry (the price of a single share of stock) and because of the requirement that they must payout at least 90 percent of their “taxable income:” in the form of dividends to shareholders in order to avoid federal taxes.
Investors are drawn to private market options for their transparency and investor-first approach. By putting the investor first, private MHP funds allow investors to gain access to management to essentially interview them in order to align their own investment objectives with those of the funds.
The long-term nature of private MHP investments ensures that these funds not only deliver superior returns to their investors vs. their public REIT counterparts but with less volatility.
That’s why savvy investors interested in investing in MHPs prefer private funds over public REITs.