Non-Publicly Traded REITs - Words of Caution

Wealth Management

By David Stephan

Non-publicly traded REITs (Real Estate Investment Trusts that are not sold or traded on a stock exchange) have been marketed as a way to have low volatility and high yield in a world that is void of investments that match those characteristics. Investors being wooed by these features might not be asking the right questions about these investments, or reading the fine print. These types of REITs can be extremely risky for the individual investor to own. In this article, we highlight three concerns that should be closely investigated before an investor commits funds: pricing, fees, and liquidity.

Pricing: Prices of publicly traded funds are reported daily. However, non-publicly traded REITs are sold at a fixed price, usually $10 per share, to assure 0% volatility in their price movements. This is deceptive and risky because the actual value of the underlying investment is never really known. Many investors mistakenly assume that the value remains at $10, but just like any other investment, its value is always changing and can be volatile. Recently, FINRA established a rule that the Net Asset Value (NAV) of non-publicly traded REITs must be revalued no later than 18 months after the last issuance. This has led to revaluations of some non-publicly traded REITs well below the issued $10 NAV, leaving investors wondering what happened, and with very few options. Additionally, the NAV is established by the firm, not an independent third-party or the marketplace.

Fees: Fees for non-publicly traded REITs can make your head spin and erode your return. Research performed by the Securities Litigation and Consulting Group of 57 Non-traded REITs shows an intricate web of fees that the REIT investors must pay. The group found that, on average, brokers can be paid fees of 15%-20% up front on the purchase. At 20%, a $10 investment has up to a $2 loss the instant it is purchased. The Group also found non-publicly traded REITs have numerous yearly or transaction-related fees to “external” advisors as well. Property managers to the REIT will charge 2%-3% of the gross revenue they manage. Real estate advisors to the REIT may also receive a commission of up to 3% of the price for any property sold to the REIT. Acquisition advisors to the REIT also receive fees of up to 6%, and additional expense payments of up to 2%. Fees for construction are about 4%-6%, and financing coordination fees can equal about 1%. The additional fees just keep going and going. But here is the kicker; the group found that most of these “external” advisors are actually wholly owned subsidiaries of the REIT. In essence, all of these fees go right to the management of the REIT.

Liquidity: Publicly traded REITs can be liquidated any time the stock market is open. Non-publicly traded REITs, however, can be exchanged in a few different ways, but the owner appears to be at a great disadvantage. There can be redemption by the issuing company (usually max of 5% of the weighted-average) with a varying schedule over 4 years, with the final year usually being the lower of $10 or 100% of the current value. Redemptions can be discontinued at any time by the issuing firm, as can the dividends. Some firms specialize as an intermediary for buying and selling non-publicly traded REITs by setting up an auction, or through tender offers. On average, this leads to selling shares at a large discount to the purchase price. The discount is because the buying party loses the redemption feature of the shares, or the value of the shares is deemed to be lower than the NAV disclosed by the REIT. Adding insult to injury, the owner must also pay the additional fees/commissions to sell the shares.

Even if the government enforces daily NAV revaluation on these investments, the investor could still be burdened by excess fees and illiquidity. While in the short-term, the higher-than-normal dividend is attractive, the total return over time and lack of liquidity cannot be ignored. Before investing, be sure to understand the fine print. 

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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.


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