What is a REIT?
A Real Estate Investment Trust (“REIT”) is a company that owns or finances real estate. The real estate could include office buildings, apartments, shopping malls, restaurants, mortgages, etc. Most REITS purchase assets as part of their own investment portfolio. REITS allow investors to earn a share of the income produced by the underlying assets. A REIT structure can offer an investor an opportunity to invest in real estate at a lower cost than they might otherwise have.
What are Non-Traded REITs?
Non-traded REITs pool investor capital to purchase portfolios of investments in real estate properties. Unlike REITs which trade on a national securities exchange, non-traded REITS (as their name implies) are not publicly traded and are, therefore, difficult to value and carry significant illiquidity risk. These types of REITs also carry tax consequences and early redemption fees, of which an inexperienced investor may be unaware.
The value of a non-traded REIT is set by the very company which sells it. Unlike a listed, or public, REIT which is valued daily based on the market in which it is traded, a non-traded REIT's value is determined by the staff of the REIT, or sometimes by a third party consultant paid for by the REIT.
Non-traded REITs also force investors to sell their shares through the REIT's own procedure. The usual procedure is to sell shares through a redemption program however, many such programs have been suspended due to adverse financial conditions when many investors attempt to redeem their shares at once. The consequence to investors is that they are stuck in the investment until the redemption program is reinstated.
However, REITs often pay a high dividend, and the selling brokers sometimes tell investors that a liquidity event (public listing) could happen in the future that will allow them to get their principal out.
The Downside Risks of Non-traded REITs
Brokers have a duty to explain the dangers of Non-Traded REITs to investors before they recommend them. Some of the known dangers of this type of security investment are:
- Large upfront fees. The front-end fees on Traded-REITs can run up to seven percent while the front-end fees for Non-Traded REITs can be as high as 15%. For many investors, investments with much lower commissions and fees such as mutual funds are a better choice. Traded REITs that can be bought in secondary markets are also usually a better choice. Brokers, at a minimum, must explain the choices and the alternative investments to fulfill their duties to the investor.
- Non-Traded REITs are not as safe and stable as they purport to be. Brokers may claim these investments are stable and predictable. FINRA and the SEC have stated that the reverse is often true.
- Early redemption can be costly and is often restrictive. There are often limits on the number of shares that can be redeemed before liquidation.
- Lack of property specification. With Non-Traded REITs, the properties are often not identified, at the time of purchase. Instead, they’re part of a blind pool.
- Lack of liquidity.
- Share Value Transparency. While market prices for REITS are available to investors, the actual value of the underlying assets is much more difficult to ascertain. Also, non-traded REITS often do not provide an estimate of share value until 18 months after their offering closes.
- Conflicts of Interest. Non-traded REITS use external managers who are paid significant incentive fees based on assets under management. These fees may not be in the best interest of investors.
Non-traded REITs typically come with high fees and commissions, which make them attractive products for brokers, even though a non-traded REIT would be a suitable investment for only a small percentage of a broker’s clientele.
Stockbrokers have a duty to make certain that any recommended investment strategy is suitable for a customer. This includes (among numerous factors): making certain that a customer does not get over-exposed to one particular investment or type of investment, that the customer can afford the risk presented by a given investment, and that the customer’s investment goals and time horizon are compatible with the recommended product. Brokers are also obligated to explain the features and risks of the investments they recommend. Fraud? Contact Counsel Hound for a free consultation!