What Is a Real Estate Operating Company (REOC)?
Let me explain what a real estate operating company, or REOC, really is. It's a publicly traded company that puts its money directly into properties, mostly commercial real estate. You should know that unlike real estate investment trusts (REITs), REOCs take the profits they make and plow them right back into their operations, and they end up paying higher corporate taxes as a result.
Key Takeaways
- A real estate operating company (REOC) engages in real estate investments and trades on a public exchange.
- REOCs can reinvest their earnings back into the business rather than distribute them to unitholders the same way REITs are compelled to do.
- REOCs have the potential for greater growth prospects than REITs but they might not generate as much immediate income.
Understanding Real Estate Operating Companies (REOCs)
If you're looking to diversify your investments and include real estate in your portfolio, you have several choices. Buying actual property is one way, but that comes with high costs and significant risks. When you purchase residential or commercial real estate, you have to handle the financial load of buying and maintaining it, plus deal with the uncertainties of the housing market.
This is where REOCs come in—they can protect you from some of those risks associated with owning physical property. By buying just a few shares in a REOC, you get instant access to a variety of real estate types, all selected and managed by experts.
Most of what they hold is commercial, like retail stores, hotels, office buildings, shopping malls, and multifamily homes. Many REOCs also invest in and manage these properties directly. For example, a company might sell or lease units in a multifamily home or office building to different tenants, while still maintaining and profiting from shared areas like parking lots and lobbies.
Shares in REOCs trade on exchanges just like any other public company, so you can buy them through your broker or financial advisor. While they remove the hassle of holding physical property, remember that REOCs still carry market risks, including interest rate risk, housing market fluctuations, liquidity risk, and credit risk.
Important Note on REOCs
Here's something key: REOCs pay federal taxes because they aren't obligated to distribute their earnings to shareholders.
REOCs vs. REITs
Both REOCs and REITs invest in real estate, but there are clear differences in how they function and strategize. REITs own and operate income-generating properties through rents or leases, which could include residential units, hotels, or even infrastructure like pipelines and cell towers. As an investor, you can pick from equity REITs, mortgage REITs, or hybrid versions.
REOCs are set up to reinvest their earnings back into the company instead of paying them out to shareholders. This means they can grow by buying new properties, improving existing ones, or even acquiring properties to sell later for profit. Because of this reinvestment, REOCs don't get the tax breaks that REITs do, so they pay higher taxes.
To be a REIT, a company has to meet specific rules, like investing at least 75% of assets in real estate and distributing at least 90% of earnings to unitholders. In return, REITs enjoy lower corporate taxes and are exempt from federal taxation. REITs often choose properties that minimize risk due to their tax status, and their strategies are geared toward long-term holding rather than buying to sell, which some REOCs do.
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