Investors are always searching for consistent cash flow, capital appreciation and tax advantages. Non-traded REITs offer such opportunities.
A real estate investment trust, or REIT, is an entity that owns income-generating real estate property. Non-traded REITs are real estate investments with company shares that are not listed on a public exchange.
Non-traded REITs include office space, multifamily properties, shopping centers, hotels or warehouses, among others. Companies in the business of non-traded real estate buy, develop and operate a property to hold the asset in their portfolio for the long term to allow for appreciation.
While non-traded REITs can be a great way to generate higher yield and diversify your investment portfolio with an uncorrelated asset, they have individual risks compared with their publicly traded counterparts. Here’s what interested investors need to know about this asset class:
— What are non-traded REITs.
— Is a non-traded REIT a good investment?
— Publicly traded versus non-traded REITs.
What Are Non-Traded REITs
There are two types of non-traded REITs: private REITs and public non-listed REITs.
Private REITs require institutional or accredited investors to have a certain net worth to qualify for the investment opportunity. Public non-listed REITs, however, are open to non-accredited investors. Both REIT options have minimums that typically range around $1,000 or higher.
While non-traded REITs are registered with the U.S. Securities and Exchange Commission and are therefore regulated, they’re not traded on a public exchange. Private REITs are not subject to most SEC regulatory requirements. This makes non-traded REITs illiquid investments since investors are unable to easily flow in and out of investment transactions like publicly traded REITs.
Investors have the potential to generate substantial returns with non-traded REIT investments, potentially paid through distributions or dividends from rent payments. In particular, when interest rates are low, income-seeking investors may turn to these higher-yielding investments.
“Non-traded REITs offer less volatility, higher income as a percentage of the total return and low correlations to the public equity market,” says Raj Dhanda, CEO at Black Creek Group in Denver.
“By adding private real estate to a portfolio of stocks and bonds, it may increase returns, provide income and reduce risk over time,” Dhanda adds.
Since REITs are not taxed, non-traded REITs also provide tax benefits, which reduces your tax bill and thereby secures a better return on your investment, real estate investment experts say. Whether you classify your REIT dividends as ordinary income, capital gains or return of capital, each is taxed at its own rate.
To invest in non-traded REITs, investors often work with an individual broker or financial advisor. Non-traded REITs are high-commission investment products, in which sales representatives, who receive a commission, present different deals.
Is a Non-Traded REIT a Good Investment?
Given their unique characteristics compared with publicly traded REITs, non-traded REITs have their risks.
Non-traded REITs carry high fees. Some of these fees include upfront charges like a commission from the sales representative or firm that presents the deal, along with transaction and organizational costs and property acquisition and asset management fees.
According to the SEC, fees can represent up to 15% of the offering price. But with the proliferation of real estate crowdfunding platforms, investors can access non-traded REITs online with lower fees.
Non-traded REIT transactions are notorious for their lack of transparency. Inexperienced investors may be unable to make a good judgment on a non-traded REIT since they may not be able to understand all the upfront and back-end costs, clouding the value of the investment. When reviewing an investment opportunity, investors should inquire about how much the sales representative or firm will be receiving in commissions, the property’s projected performance and fees, experts say. That way, you can determine if the REIT is right for you.
But as Dhanda says, “Private real estate has really evolved over the past couple of decades and now offers investors more transparency, monthly liquidity and alignment with the investment manager.”
While acknowledging the risks that come with non-traded REITs, it’s important to recognize their merits, too.
“There is a great scarcity of uncorrelated income in today’s market and these investments are a good fit for that,” Dhanda says.
Non-traded REIT investments are suitable for investors who have a long-term investing strategy. Investors can be locked in a non-traded REIT transaction for several years before realizing a profit. Deciding to bow out of an investment early could result in high fees or a loss in total return. For this reason, investors need to consider their short-term risk tolerance when investing in non-traded REITs.
Choosing to liquidate shares before a liquidity event can pose challenges to investors since non-traded REITs can put restrictions on the number of shares that can be redeemed. If a redemption program allows you to liquidate early, your shares may be sold at a lower value than originally purchased.
Publicly Traded vs. Non-Traded REITs
As a consequence of publicly traded REITs being listed on a stock exchange, they are subject to market volatility and sentiment. But stock market swings are not a concern for non-traded REITs, and investors don’t have to worry about day-to-day price movements. Their valuation is determined by the value of the asset itself. This is why understanding a property’s intrinsic value and making sure it’s valued properly is so important.
Andrew Aran, managing partner at Regency Wealth Management in Ramsey, New Jersey, says investors don’t have to focus on near-term valuation fluctuations that public REITs have.
“Non-traded REITs can take a longer-term horizon in managing their investments,” he says.
What may be a concern for non-traded REITs is that “the cyclicality (economic sensitivity) of real estate and funding risks often result in earnings and valuations having periodic volatility,” Aran observes.
Investments in public REITs require the purchase of one share, the typical starting investment amount for non-traded REITs ranges from $1,000 to $2,500, according to the SEC.
Furthermore, while public REIT investments use indexes for performance benchmarks, non-traded REITs do not have an independent benchmark for performance comparison. This is where investors would have to rely on the companies they’re doing business with to provide reliable updates on property details.
Given the different risks and rewards that come with both public and non-traded REITs, investors can benefit from both asset classes in their portfolios. Dhanda says public and private REITs have a role in a portfolio; it’s not an either-or situation.
Considering the numerous risks, non-traded REITs may be a better consideration for investors who have experience in this space and are willing and able to take on unique risks.
“There is certainly potential for conflicts of interest, liquidity issues and outsized transaction fees,” cautions Anish Malhotra, CEO and co-founder at Plotify, a technology-focused real estate asset manager and platform.
“My advice to anyone investing in private REITs would be to carefully analyze the incentives of the various parties involved in the management, oversight, and sales/marketing process so that you are aware of the potential issues and conflicts that can arise,” Malhotra says.
More from U.S. News