REITs are gaining popularity among real estate investors, but the products can be risky. Learn more about the investment risks posed by different types of REITs.
REITs are the most popular alternative investments among affluent Americans, but the products can expose real estate investors to a high level of investment risk. What are REITs? How do they vary?
REIT stands for Real Estate Investment Trust, a corporation that owns commercial real estate, such as hotels, rental apartments, shopping centers and storage units. The corporation purchases its property by pooling assets from numerous real estate investors and, in exchange for preferential tax treatment, returns 90 percent of its taxable income to its shareholders. Beyond these common features, REITS can differ in significant ways, and these differences have important implications for real estate investors.
REITs fall into three broad categories, public exchange-traded REITs, public non-traded REITs and private REITs. Both types of public REITS are registered with the U.S. Securities and Exchange Commission and must file a prospectus, as well as quarterly and annual reports. Exchange-traded REITs can be bought on national securities exchanges, and are considered to be fairly liquid investments, easy for real estate investors to buy and sell.
Non-traded public REITS are not listed on national securities exchanges and can be extremely illiquid, according to the Financial Industries Regulatory Authority, or FINRA, which regulates broker-dealers. Non-traded public REITs can also charge relatively high front-end fees of up to 15 percent that can “erode total return.” Many non-traded REITs lock in funds for a set period, after which the trust must liquidate or go public, but, according to FINRA, “there is no guarantee that the value of your investment will have gone up – and it may go down or lose all its value.” Early redemption of non-traded REIT shares may involve restrictions and expensive penalties.
Private REITs, or private-placement REITs, carry “significant risk” to real estate investors, according to FINRA. They are not listed on national securities exchanges and are generally exempt from SEC reporting requirements, according to FINRA. The lack of disclosure can make it difficult for investors to make informed decisions about private REITs and the investments are typically sold only to more affluent and sophisticated investors accredited by the SEC.
REITs have gained appeal among affluent investors seeking income in a time of extreme stock market volatility and low interest rates, but all REITs pose investment risk. For one, REIT distributions are not guaranteed and can be suspended or halted. Distributions can also be funded through investor capital or borrowing, and this leveraging can increase the risk a REIT will default or lose value – risk more typically associated with non-traded REITs, according to FINRA.
FINRA recommends the following tips to real estate investors considering non-traded REITs:
· Do not put all your assets in a single REIT or REIT family. Older investors, in particular, should “be cautious” about investing large portions of their retirement nest egg in a single REIT.
· Do not invest solely based on current distributions of a non-traded REIT. The distributions can be suspended or halted, and may be funded through borrowing.
· Redemption policies of non-traded REITS can change, making the products difficult to sell.
· Be wary of claims that a non-traded REIT is about to go public. The process is lengthy and may never come to pass. If it does, shares may trade at a lower price that the current valuation.
· Be cautious about investing proceeds from one non-traded REIT into another, especially if both REITs are sold by the same securities firm.
· Real estate investors considering a non-traded REIT are urged to thoroughly research the product through its investor relations department and the SEC’s EDGAR database.