Non traded reits

What Are Non-Traded REITs?

Non-traded real estate investment trusts (REITs) are investment vehicles that own, operate, or finance income-producing real estate. As their name suggests, unlike publicly traded REITs, shares of non-traded REITs are not listed or traded on national securities exchanges. Instead, investors typically purchase non-traded REITs directly through broker-dealers or financial advisors. These types of REITs fall under the broader category of real estate investment and are often considered a form of alternative investments due to their unique characteristics, particularly their lack of daily liquidity. Like all REITs, non-traded REITs are generally required by the Internal Revenue Service (IRS) to distribute at least 90% of their taxable income to shareholders annually.³²,³¹ This structure aims to provide investors with potential for income-producing properties and capital appreciation.

History and Origin

The concept of REITs was established in the United States by Congress in 1960 through the Real Estate Investment Trust Act, signed by President Dwight D. Eisenhower. The original intent was to provide all investors, including smaller ones, with access to income-producing real estate and the benefits traditionally enjoyed by large financial intermediaries and wealthy individuals.³⁰,²⁹ This legislation allowed for the pooling of capital from numerous investors to acquire portfolios of properties. While publicly traded REITs soon became a standard way to invest in real estate on exchanges, the market for non-traded REITs developed to offer access to real estate portfolios without the daily price volatility of a public market. Over the years, the structure of non-traded REITs has evolved, with continuous efforts by regulators like the Financial Industry Regulatory Authority (FINRA) and the U.S. Securities and Exchange Commission (SEC) to inform investors about their specific features and risks.²⁸,²⁷

Key Takeaways

• Non-traded REITs are investment vehicles that own and manage real estate but do not trade on public stock exchanges.
• They typically offer limited liquidity, meaning investors may face challenges in selling their shares quickly.²⁶
• Non-traded REITs are subject to high upfront fees and ongoing management expenses, which can impact overall returns.²⁵
• Distributions from non-traded REITs may be paid from sources other than operating cash flow, potentially including investor capital or borrowings.²⁴,²³
• Valuation of non-traded REIT shares is often based on periodic appraisals, rather than real-time market pricing, making price transparency limited.²²

Interpreting Non-Traded REITs

Interpreting a non-traded REIT largely involves understanding its underlying real estate portfolio and its stated investment objectives. Since there is no public trading market, the share valuation is not determined by supply and demand on an exchange. Instead, the value per share is often based on periodic appraisals of the properties owned by the non-traded REIT, which may not be timely or reflect immediate market changes.²¹ Investors should scrutinize the nature of the real estate assets held, the experience of the management team, and the disclosed fees. Emphasis is typically placed on the potential for steady distributions and long-term capital appreciation from the underlying real estate. However, it's crucial for investors to understand that these distributions are not guaranteed and can fluctuate.²⁰ The lack of daily price discovery means that investors cannot easily gauge the market's current sentiment or the immediate performance of their investment.

Hypothetical Example

Consider an investor, Sarah, who decides to put $10,000 into a non-traded REIT. This non-traded REIT aims to acquire a portfolio of commercial properties, such as office buildings and retail centers. Upon her investment, a portion of her initial $10,000 (e.g., 7-15%) goes towards upfront fees, including selling commissions and organizational costs.¹⁹ So, if the upfront fee is 10%, only $9,000 of her money is actually invested in the real estate assets.

Over the next few years, the REIT collects rent from its properties and distributes a portion of its income to shareholders, providing Sarah with regular cash payments, similar to dividends. However, she notices that her account statement does not show a fluctuating daily share price like a stock would. Instead, the REIT's value per share is updated periodically, perhaps annually, based on appraisals of its properties. After seven years, the non-traded REIT reaches its "finite life" and initiates a "liquidity event," such as selling its portfolio or listing on an exchange. At this point, Sarah receives proceeds from her investment, which reflect the performance of the underlying properties, minus any remaining fees or expenses. Her overall return is the sum of the distributions received plus any capital gained or lost upon the liquidity event, relative to her net invested investor capital.

Practical Applications

Non-traded REITs are primarily offered to individual investors seeking exposure to diversified real estate portfolios without the need for direct property ownership or management. They can be seen as a way to achieve portfolio diversification by adding real estate assets, which may have a low correlation with traditional stocks and bonds. These investment vehicles are often utilized by those looking for potential income streams through regular distributions.

However, it is important to note that due to their illiquid nature and fee structures, non-traded REITs are generally considered suitable only for investors with a long-term investment horizon and those who do not anticipate needing access to their invested capital quickly. The Financial Industry Regulatory Authority (FINRA) has issued investor alerts emphasizing the need for careful review before investing, highlighting risks such as limited liquidity and high fees.¹⁸

Limitations and Criticisms

Non-traded REITs come with several significant limitations and criticisms, primarily centered around their lack of liquidity, high fees, and valuation transparency. The most prominent limitation is the absence of a public trading market, which makes non-traded REIT shares illiquid. Investors typically cannot sell their shares readily on an open exchange and may have to wait for a "liquidity event," such as the REIT listing on an exchange or liquidating its assets, which can take many years, often seven to ten or more.¹⁷ Share redemption programs, if offered, are usually limited and can be suspended or discontinued at the REIT's discretion, and redemptions may occur at a discount to the original purchase price.¹⁶

Another major criticism is the elevated fee structure. Non-traded REITs often charge substantial upfront fees, sometimes as high as 15% of the offering price, which can significantly reduce the amount of investor capital actually invested in properties.¹⁵ These fees commonly include selling commissions and organizational costs. Furthermore, ongoing management fees and property acquisition fees can also be substantial. Critics argue that these high fees can materially erode returns for investors.¹⁴

Concerns also exist regarding valuation. Without a public market price, the value of non-traded REIT shares is based on periodic appraisals, which may not accurately reflect real-time market conditions or the true underlying value of the assets. This lack of transparency can make it difficult for investors to assess the true performance of their investment. Research indicates that non-traded REITs have historically underperformed comparable publicly traded REITs, even after accounting for their illiquidity, with some studies showing significant cumulative shortfalls for investors.¹³ FINRA has previously investigated potential misrepresentations by brokers regarding fees, dividends, and liquidity, underscoring the need for investors to conduct thorough due diligence.¹²

Non-Traded REITs vs. Publicly Traded REITs

The fundamental difference between non-traded REITs and publicly traded REITs lies in their market accessibility and liquidity.

While both types of real estate investment trusts (REITs) invest in income-producing real estate and are subject to similar IRS distribution requirements, the illiquid nature of non-traded REITs and their often higher fee structures are key distinguishing factors. Investors often confuse them with private equity real estate funds or private REITs, which are generally exempt from SEC registration and typically sold only to accredited investors.⁷,⁶

FAQs

Are non-traded REITs regulated?

Yes, most publicly offered non-traded REITs are registered with the U.S. Securities and Exchange Commission (SEC) and are required to file regular disclosures, including quarterly and annual reports.⁵ However, this registration does not imply SEC endorsement or guarantee performance.

How do non-traded REITs generate returns?

Non-traded REITs generate returns primarily through income from their real estate properties (e.g., rent from tenants) and potential appreciation in the value of those properties. They distribute a significant portion of their taxable income to shareholders as dividends.⁴

What happens when a non-traded REIT "liquidates"?

When a non-traded REIT liquidates, it typically sells its portfolio of real estate assets. The proceeds, after expenses and debt repayment, are then distributed to shareholders, providing them with a return of their capital and any accumulated profits or losses. This "liquidity event" can also involve the REIT listing its shares on a national securities exchange.³

Are non-traded REITs a safe investment?

Non-traded REITs are not considered risk-free investments. They carry risks such as illiquidity, high fees, potential conflicts of interest with external managers, and the risk that distributions may not be sustainable or may be paid from borrowed funds or investor principal.² Investors should be prepared for long holding periods and the possibility of losing money.

Can I sell my non-traded REIT shares easily?

No, selling non-traded REIT shares is generally not easy. Unlike publicly traded securities, there is no active secondary market for non-traded REITs. While some may offer limited share redemption programs, these are often subject to restrictions, fees, and can be suspended or terminated at the REIT's discretion.¹