Over the years, Real Estate Investment Trusts (REITs) have grown in popularity among investors by offering higher-than-average dividend yields and a relatively low level of volatility compared to other stock sectors like technology or energy.
REITs can be broken up into three distinct categories: publicly traded REITs, non-traded REITs, and private REITs.
Traded REITs are the ones most investors are familiar with. They are registered with the SEC, offer full transparency to investors, and trade like traditional stocks experiencing ups and downs as the market fluctuates.
Non-traded REITs are similarly registered with the SEC, but don’t trade openly on any market exchange. Investors must qualify as an “accredited investor,” and transparency and liquidity is limited. However, these REITs are not subject to market fluctuations and offer a “pure play” on the real estate market.
Private REITs are not registered with the SEC, nor do they trade on exchanges. Rather, they are designed as limited partnerships in which investors commit some threshold value of capital and the general partners make the investment decisions. To qualify, investors must meet the criteria of an “accredited investor” and are usually not able to withdraw their investment for at least 2 years or more.
Non-traded REITs fill the gap between traded REITs and private placement REITs. According to investment bank Robert A. Stanger & Co., fundraising for non-traded REITs was up 137% for the first three quarters of 2019 compared to the same period in 2018, with the total as of the end of September 2019 at $7.6 billion. This is a significant increase compared to the same-period total in 2018. In fact, sales of non-traded real estate investment trusts topped $2.4 billion as recently as January 2020.
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How Does a Non-Traded REIT Work?
A non-traded REIT usually solicits investors through a “blind pool.” While investors may have some general information regarding the REIT’s stated goals, they don’t have access to the details of how their investment will be used.
The life-cycle of a non-traded REIT can be explained as a 5-step process:
1. Investors contribute capital to purchase shares in the REIT.
2. General partners use investor capital to invest in real estate properties.
3. REIT portfolio and properties are managed.
4. REIT realizes capital gains and distributes at least 90% of its taxable income to investors.
5. Exit strategy is initiated by the REIT either by liquidating its assets or listing on an exchange to become a publicly traded REIT.
It should be noted that liquidity in non-traded REITs is limited. Investors should plan for a long-term holding strategy for the lifetime of the REIT and realize gains only upon the REIT’s IPO or property liquidation. The return of capital is dependent upon the value of the REIT’s underlying properties and may be more or less than the original investment amount.
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Similarities Between Traded REITs and Non-Traded REITs
Traded and non-traded REITs have some commonalities. Both types of REITs are registered with the SEC and are subject to regulation guidelines. They also have an obligation and are required by the SEC to meet the “90% distribution” requirement. At least 90% of taxable income must be distributed to shareholders.
Check out the different types of REITs here.
Differences Between Traded REITs and Non-Traded REITs
There are a number of differences between traded and non-traded REITs.
Non-traded REITs have stricter eligibility requirements. Like private-placement REITs, investors must qualify as an “accredited investor” with a net worth of $1,000,000 or an annual income of $200,000 for the past 2 years.
Transparency is another big difference between the two types of REITs. In a non-traded REIT investors may not have access to the actual properties that the REIT has invested in and may only be aware of the general type of real estate investment the REIT prefers. “Blind pools” are common in the capital-raising stage, making it more difficult for investors to perform due diligence.
Income distribution is uncertain for non-traded REITs. Whereas a publicly traded REIT offers a dependable quarterly dividend, distributions from non-traded REITs are dependent upon the board’s decisions and income from investment properties. An unfavorable interest rate environment and a relatively higher fee structure can result in a negative cash flow, leaving no money left for income distribution to investors.
Liquidity in a publicly traded REIT is high – investors can gain access to their capital by simply selling shares of the stock. In a non-traded REIT, investors usually have just two options: wait for the REIT to have an IPO and become a publicly traded entity, or wait for the REIT to liquidate its holdings.
Fees for non-traded REITs also tend to be significantly higher than those found in publicly traded ones. Front-end load fees of 12% to 15% are common, while acquisition, asset management, asset disposition and incentive fees may also be applied.
Not sure about the differences between a public and a private REIT? Check out this article to know more.
Considerations for Investors
There are a number of factors that investors should keep in mind before deciding whether a non-traded REIT is right for them or not. Other than the possibility of needing to qualify as an “accredited investor,” the lack of liquidity and higher fees can be detrimental for some investors.
The regulatory environment is constantly changing as well. After the real estate market crashed in 2008, interest rates plummeted in order to spur business investment and stimulate the economy. With yields at all-time lows, investors scrambled for anything that offered higher-than-average yields – something that non-traded REITs offered. However, a change in how non-traded REITs were required to report value based on assets and liabilities rather than share offering prices resulted in a restructuring of how management fees were to be calculated.
In short, investors need to do their own due diligence and make sure their investment objectives are aligned to a non-traded REIT’s performance potential.
The Bottom Line
Before selecting the type of REIT you want to add to your portfolio, you’ll want to fully understand the risks and rewards for each one. Non-traded REITs offer investors a “pure play” on the real estate market without having to account for stock valuation issues. But large fees, unreliable income distribution, and a lack of liquidity in non-traded REITs may make publicly traded REITs preferable for some investors.
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