Internal or External Management in Real Estate Investement Trusts (REITS)


REITs are either internally managed, with management as employees, or "externally managed", pursuant to a management contract, with no direct employees.

Usually, private REITs (or non-traded REITs) are externally managed for a fee by a related-party manager. The related party fees for these types of vehicles can be significant, and will vary based on the underlying investment premise and management services rendered.

In a REIT with an internal management structure, its own officers and employees manage the portfolio of assets. Conversely, a REIT with an external management structure usually resembles a private equity arrangement, in which the external manager receives a flat fee and an incentive fee for managing the REIT's portfolio of assets.

There has always been a debate over which management structure is most favorable, and the controversy seems to always center on conflicts of interest. Let me explain.

When you buy shares in a publicly traded REIT that is internally managed, you are providing capital (or equity) to the company to invest in buildings and pay the overhead (including salaries) for the business. So, theoretically, as an investor I am paying for the salaries of the management team.

However, when you buy shares in an externally managed REIT, you are not actually hiring the management team. The Board has negotiated a contract with an outside management team to run the business, and typically, their compensation is tied directly to growing assets under management, much like the private equity model.


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