Real Estate Operating Companies (REOCs): Definition & How They Differ from REITs

A real estate operating company (REOC) is a company that owns and operates real estate properties, and its shares trade in public exchange markets, such as the New York Stock Exchange (NYSE)New York Stock Exchange (NYSE)The New York Stock Exchange (NYSE) is the largest securities exchange in the world, hosting 82% of the S&P 500, as well as 70 of the biggest and NASDAQ. Unlike real estate investment trusts (REITs), REOCs are allowed to reinvest a majority of their earnings into the new and existing projects.

On the other hand, REITs are required to distribute a higher proportion of their earnings back to the investors. REOCs operate as for-profit companies that are subject to standard corporate taxes like other companies.

How an REOC Operates

A real estate operating company owns and operates different types of commercial real estate projects. They also fund real estate projects, which they sell as houses, offices, hotels, and department stores. REOCs may also retain the right to operate and manage such properties.

For example, after selling individual units of a corporate building as offices, the company can retain the right to manage common areas, such as hall service, parking bay, corridors, electricity, etc. REOCs may also purchase established buildings with the goal of improving their design to increase their value and later sell them at a higher price. In essence, REOCs are more flexible in terms of the investments that they can pursue compared to REITsReal Estate Investment Trust (REIT)A real estate investment trust (REIT) is an investment fund or security that invests in income-generating real estate properties. The fund is operated and owned by a company of shareholders who contribute money to invest in commercial properties, such as office and apartment buildings, warehouses, hospitals, shopping centers, student housing, hotels since they are not restricted in the type of investments they can make.

Furthermore, REOCs face more lenient regulatory constraints, which gives them more flexibility in terms of how they invest their revenues and the projects they can undertake. The lenient regulatory framework also means that they do not benefit from the lower corporate tax rates enjoyed by other real estate companies, such as REITs. Also, they are not exempted from the federal tax laws at the entity level.

Real Estate Investment Trust vs. Real Estate Operating Company

Although both the REITs and REOCs operate in the real estate industry, they vary in their routine functions and operations. The following are the differences between the two types of companies:

1. Types of investments

REITs are the majority in the real estate sector, and they account for about 85% of all publicly held real estate companies. The core operating strategy of REITs is to generate cash flows for shareholders by leasing and renting properties under their management. Some of the properties that REITs invest in include shopping malls, apartments, warehouses, office buildings, and hotels.

REITs are required to pay a majority of their net revenues (at least 90%) to their shareholders as dividendsDividendA dividend is a share of profits and retained earnings that a company pays out to its shareholders. When a company generates a profit and accumulates retained earnings, those earnings can be either reinvested in the business or paid out to shareholders as a dividend., while the remaining portion can be re-invested into real estate properties. The investment model of REITs allows them to make huge revenues within a short duration.

REOCs, on the other hand, follow a different investment style that allows them to make long-term investments. One of the ways that REOCs make money is by financing new real estate constructions and selling them to investors for a profit. REOCs also buy established properties with the goal of renovating them using the latest building standards and selling them at a profit.

Apart from buying and financing constructions, REOCs may also be appointed as property managers to oversee a chain of properties and earn a monthly management fee as agreed with the property owners. The revenues earned are mostly reinvested into current and new projects that allow them to grow their portfolio of properties at a rapid pace.

2. Investor expectations

When investing their money in real estate companies, investors adhere to different goals and expectations. Investors in REITs are often looking for consistent passive cash flows at the end of every month, quarter, or financial yearFiscal Year (FY)A fiscal year (FY) is a 12-month or 52-week period of time used by governments and businesses for accounting purposes to formulate annual, depending on the type of their investments. Investors looking for consistent returns on their investments are more attracted to REITs than REOCs since the former are required by law to distribute a majority of their earnings to shareholders.

Investors who choose to invest in REOCs are more interested in capital gains, where they earn a higher return for an asset than they originally paid for it. It means that investors will be more interested in getting favorable valuations on their real estate properties, a higher return on equity, or a greater return on their initial investment in the company. Investors who put liquid capital into the company are more interested in knowing the type of investments that the company is investing in and the returns they expect to get in the future.

Taxation Laws

REITs enjoy a special tax status under U.S. tax laws that exempt them from federal taxes if they meet certain statutory requirements. One of the requirements is restraining their investments to specific commercial real estate activities that are less risky and that safeguard the investors’ funds.

Another requirement is that they must agree to distribute out a large proportion of their net revenues as dividends to shareholders. REOCs, on the other hand, do not enjoy any special tax status, and they pay regular corporate taxes like other corporates operating in the United States.

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