REITs (Real Estate Investment Trusts) have become a popular investment vehicle due to the potential for diversification, regular income stream, and access to institutional grade real estate investments. But not all REITs are the same. There are three main types of REITs, each of which must be evaluated to ensure they are a worthwhile investment that fits within the investor’s desired investment strategy.
Investing in a publicly-traded REIT done via a similar process to investing in other exchange traded public securities. Shares can be bought and sold on exchanges like NYSE and NASDAQ, making them highly liquid with standard trading fees. Additionally, there is no accreditation requirement which means anyone can invest.
Because these REITs are listed on the public market, valuation is determined by the market and changes daily. This also means that publicly-traded REITs are highly correlated with the stock market and are subject to market volatility. As a result, managers of traded REITs may have more of a focus on producing short term earnings rather than long-term growth. The trust must be registered with and is regulated by the SEC. This means they are required to make regular disclosures, including quarterly and annual audited financial reports.
Non-traded REITs are similar to publicly-traded REITs in that they are still registered with the SEC and subject to the same regulations and reporting requirements. They also maintain availability to all investors regardless of accreditation. However, they are not listed on exchanges, which results in a number of other differences as well, including liquidity, fees, and volatility.
Instead of being available on exchanges, shares of non-traded REITs are usually sold through broker-dealers, who may charge high up-front fees that can reduce principal and any eventual return. Selling shares can be significantly more difficult than those of traded counterparts. While managers occasionally set up redemption programs, investments into non-traded REITs are considered illiquid and there is generally a minimum hold period.
Because they are not listed on exchanges, non-traded REITs have the advantage of low correlation with the stock market, which may help diversify investor portfolios.1 The value of a non-traded REIT is not subject to stock market volatility and is instead determined by an appraisal of the properties owned by the trust. This means that managers are more likely to focus on long-term investment goals.
Unlike those that are publicly-traded and non-traded, private REITs are not required to register with the SEC and are not subject to the same reporting requirements. While they are not regulated by the SEC, private REITs are required to conform to Regulation D. Private REITs are only available to accredited investors, have high investment minimums, and are highly illiquid. Much like non-traded REITs, private REITs are sold primarily by broker-dealers and may feature high fees. They are not correlated with the stock market, and are valued based on an appraisal of assets. There is usually little-to-no information about private REITs that is made available to the general public, including management strategy, performance, and fee structure, all of which vary from investment to investment.
Advisors need to consider their investors' goals and risk tolerance when deciding if they want to allocate to REITs. As with any investment, there is no guarantee of success, and there are real estate specific risks associated with REITs.2
While REITs often make regular distributions, as they are required to distribute at least 90% of their taxable earnings to investors. However, in order to maintain the regularity of distributions REIT managers sometimes subsidize those distributions with debt or even investor principal. Additionally, advisors will want to remind investors that distributions are usually taxed as normal income, rather than capital gains, which may mean a different tax rate applies than usually expected from their investments.
While non-traded and private REITs have a reputation for their ability to produce attractive risk-adjusted returns, advisors need to strongly consider the risks associated with illiquid real estate investments and weigh them against the risks of market correlation and daily price fluctuations that come with publicly traded REITs.
Opportunities for the Modern Advisor
How allocations into alternative investments and
adoption of technology tools can benefit advisors
1 Diversification does not guarantee profits and protect against losses.
2 Investments in real estate assets are subject to varying degrees of risk with respect to the underlying real estate, real estate development projects and related cash flow. All real estate investments may be subject to, among others, the following risks: loss of invested principal, possible declines in the value of real estate, risks related to general and/or local economic conditions, possible lack of availability of funds, overbuilding, extended vacancies of properties, increases in competition, property taxes and operating expenses, changes in environmental and/or zoning laws, costs resulting from the clean-up of, and liability to third parties for damages resulting from, environmental problems and/or future problems arising out of the presence of certain construction materials, casualty of condemnation losses, inadequate insurance coverage, or the failure of an insurer to pay on a claim of the insolvency of an insurer, risks from floods, hurricanes, earthquakes or other natural disasters, including uninsured damages and resignation of previously "non-flood" areas, risks of future terrorist attacks, limitation on a variation in leases/rents, changes in interest rates, changes in construction costs, changes in energy prices.