Investing in Real Estate: Direct Ownership vs REITs vs Private Funds
Investing in real estate can mean very different things. For one person it means buying a duplex in Madison and managing it on weekends. For another it means owning shares of a publicly traded REIT in a brokerage account. For a third it means committing capital to a private fund run by a professional sponsor. All three are real estate, but they differ in control, liquidity, risk, effort, and especially taxes.
This guide compares the main ways to invest in real estate and explains how each choice connects to your broader portfolio and your tax return.
Start Here: A Complimentary Wealth and Tax Review
Before choosing a path, it helps to see how real estate fits with everything else you own. Compound offers a complimentary, no-obligation wealth and tax review that may include:
Current real estate exposure: your home, rentals, business property, and real estate held inside funds
Concentration: how much of your net worth depends on one property type or one local market
Tax position: depreciation, passive losses, and how rental income currently shows up on your return
Liquidity: how much you may need to access in the coming years
Goals: income, growth, diversification, or a legacy for the next generation
Request your wealth and tax review.
Option 1: Direct Ownership
Owning property yourself, alone or with partners, gives you the most control. You choose the property, the financing, the tenants, and when to sell.
Potential advantages: control over decisions, the ability to use leverage, and direct access to depreciation deductions, which may offset some or all of the rental income on paper. Strategies such as cost segregation may accelerate those deductions on qualifying properties. See whether cost segregation makes sense for smaller portfolios.
Trade-offs: time and management responsibility, concentration in a few properties, limited liquidity, and personal exposure to vacancies, repairs, and interest rate changes. Passive activity rules may also limit how rental losses can be used against other income. When you sell, depreciation recapture and capital gains need planning, and a like-kind exchange may be worth discussing for investment property.
Option 2: REITs and Real Estate Investing in the Markets
Real estate investment trusts, or REITs, own or finance income-producing property and trade much like stocks when they are publicly listed. Real estate investing in the markets through REITs or real estate mutual funds and ETFs offers a very different experience from owning a building.
Potential advantages: daily liquidity for listed REITs, diversification across many properties and sectors (apartments, industrial, data centers, health care, and more), professional management, and small minimum investments.
Trade-offs: prices can move with the stock market, sometimes sharply, even when property values are stable. REITs are generally required to distribute most of their taxable income, and much of that distribution is often taxed as ordinary income rather than at qualified dividend rates, though a portion may be eligible for a deduction under current law. Depreciation stays inside the REIT rather than flowing to you. Because of that tax profile, many investors consider holding REITs in tax-deferred accounts, a choice worth reviewing with your advisor.
Non-traded REITs are a separate category. They may have higher fees and limited redemption options, so they deserve careful review.
Option 3: Private Real Estate Funds
Private funds pool investor capital to buy, develop, or lend against property. These are generally available only to qualified investors and are often grouped with other alternatives.
Potential advantages: access to larger or specialized properties, professional management, and diversification across several assets. Many private funds issue K-1s that pass through depreciation and other tax items, which can make the after-tax income different from what the cash distributions suggest.
Trade-offs: long holding periods, limited or no liquidity, layered fees, and dependence on the sponsor. Evaluating real estate alternative investments fund managers is a central part of the decision. Questions worth asking include how the manager has performed across full market cycles, how properties are valued, how fees and profit sharing work, how much of the manager's own capital is invested, and what happens if the fund needs more capital. Our guide to evaluating alternative investments covers this in more detail.
Comparing the Three at a Glance
Control: high with direct ownership, none with listed REITs, low with private funds
Liquidity: low with direct ownership, high with listed REITs, low with private funds
Time required: high with direct ownership, low with REITs and private funds
Depreciation to you: yes with direct ownership, no with REITs, often with private funds through a K-1
Tax reporting: Schedule E or an entity return for direct ownership, Form 1099 for REITs, K-1 for most private funds
How Investing in Real Estate Fits Your Overall Plan
Real estate decisions work best when they are made inside a broader wealth management strategy. Someone who already owns several local rentals may not need more Wisconsin apartment exposure in a fund, while someone with no real estate may consider a diversified REIT allocation. Business owners who own their building are often more concentrated in real estate than they realize.
On the tax side, tax planning and preparation that looks across all of your holdings can help coordinate depreciation, passive losses, and the timing of sales. Our tax planning guide for real estate owners explains these issues, and real estate professionals may find value in building wealth beyond real estate.
To compare how different hypothetical return and tax assumptions may affect long-term growth, try the Compound calculator. Results are hypothetical and for illustration only.
Working With Compound
Compound works with real estate investors, business owners, and families throughout Wisconsin, including Milwaukee, Madison, Waukesha, Green Bay, Appleton, Oshkosh, and La Crosse, as well as surrounding areas. Our services bring investment management, tax planning, and access to alternative investments for qualified investors together in one plan.
Request a complimentary wealth and tax review to see how real estate fits your full financial picture.
Frequently Asked Questions
What is the best way to start investing in real estate?
It depends on how much control, liquidity, and time you want. Listed REITs offer an easy entry point, direct ownership offers control and depreciation, and private funds offer professional management for qualified investors willing to accept limited liquidity.
How are REITs taxed?
REIT distributions are often taxed largely as ordinary income, with a portion possibly eligible for a deduction under current law. Some distributions may be capital gains or return of capital. Your Form 1099 shows the breakdown.
Do private real estate funds pass through depreciation?
Many do. Funds structured as partnerships typically report depreciation and other items on a K-1, which may reduce taxable income from the fund. Rules on using those losses vary by situation.
Is real estate a good diversifier?
Real estate may behave differently from stocks and bonds over time, but listed REITs can be volatile, and direct property can be concentrated. How it diversifies depends on what else you own.
What should I ask real estate fund managers?
Ask about performance across market cycles, valuation methods, fees and profit sharing, the manager's own investment in the fund, liquidity terms, and how capital calls work.
Compound is a registered investment adviser. Registration does not imply a certain level of skill or training. This article is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Tax laws are complex and subject to change. Strategies discussed may not be suitable for everyone, and there is no guarantee that any strategy will achieve its objectives or reduce taxes. Calculator results are hypothetical, are not guarantees of future results, and do not reflect any actual investment. Investing involves risk, including possible loss of principal. Real estate investments are subject to risks including changes in property values, interest rates, and market conditions. Diversification does not ensure a profit or protect against loss. Alternative investments involve additional risks, including illiquidity, and are available only to qualified investors. Please consult your tax, legal, and financial professionals before acting on any information in this article. For more information, see Compound's Form ADV, available at adviserinfo.sec.gov.
About Compound Wealth
Long-term financial planning often involves balancing tax considerations, investment decisions, business interests, and personal financial goals. Compound Wealth provides an integrated planning approach that brings these disciplines together to provide a coordinated framework for evaluating financial decisions as financial circumstances evolve over time.
