Sales of non-traded real estate investment trusts topped $1.1 billion in December 2020, the highest total since February and a 30 percent increase from the $859 million raised in November, according to investment bank Robert A. Stanger & Company. And, many of these have been sold to unsophisticated retail investors. While generally an investor can easily buy and sell shares of publicly-traded REITs, it’s much harder to sell a non-traded one. They also tend to have longer holding periods, some up to 10 years. Brokers like non-publicly traded REITS because the front-end fees are large—sometimes as much as 15% just for selling this one product. Non-traded REITS are often recommended to investors seeking income, and,  in a low-interest environment, they appeal to people because they appear to be backed by real estate assets. What most investors do not know, however, is that often these non-traded REITs are highly leveraged and may be paying their investors with this borrowed money, or just giving the investor their money back as a distribution.

Brokerage Firms Have been Fined for Improperly Selling Non-Traded REITs Non-Traded REITs have also been the subject of recent regulatory actions. It has been reported that NEXT Financial Group,  a Houston-based broker-dealer, will pay $475,000 in fines to settle charges that it placed investors in unsuitable non-traded real estate investment trusts. Some of these unsuitable sales of non-traded REITs include sales to investors over 80 years old. The Enforcement Section of the  Massachusetts  Securities Division filed a complaint against LPL Financial, LLC for improprieties in the sales of seven non-traded REITs. In recent years, LPL has come under fire from customers and regulators for what are considered the inappropriate sales of REITs. New Hampshire and New Jersey have also filed actions against  LPL over this alleged misconduct in the sale of non-traded REITs by its brokers. 

What Exactly is a REIT?

REIT, short for a real estate investment trust, is a company that owns, and generally operates, income-producing real estate or real estate-related assets.  REITs pool the capital of numerous investors to purchase a portfolio of properties—from office buildings and shopping centers to hotels and apartments, even timber-producing land—which the typical investor might not otherwise be able to purchase individually. Types of such income-producing real estate assets owned by a REIT include real assets (such as an apartment or commercial building) or real estate-related debt (such as mortgages). 

How is a Publicly Traded REIT Different from a Non-Traded REIT?

Publicly traded REITs (sometimes referred to as exchange-traded REITs) are registered with the SEC, file regular reports with the SEC, and are listed on an exchange such as the NYSE.  Similar to stocks listed on an exchange, you can buy and sell a publicly-traded REIT easily.  This is why an investment in a  publicly-traded REIT is generally often called a “liquid” investment. Because a publicly-traded REIT is listed on an exchange,  you can easily determine its value by looking up the share price at which the REIT is trading.

A non-traded REIT is also registered with the SEC and files regular reports with the SEC. However, these investments are not listed on any exchange and are not publicly traded.  

What’s a Private REIT?

A third category is the private REIT, also called a private-placement REIT. Like a  non-traded REIT, it also does not trade on any exchange. A private REIT carries significant risk to an investor. In addition to not being listed on any exchange, making them hard to value and trade, these are generally exempt from registering with the SEC, and thus it is difficult for investors to obtain information about their investment. 

For these reasons, private REITs can only be sold to accredited investors—meaning individuals who have a net worth in excess of $1 million. 

Non-traded REITs are Riskier than Publicly Traded REITs.

Because of their risky characteristics, the Securities and Exchange Commission (“SEC”) has published a list of some of the risks of investing in  non-traded REITs that investors should consider before investing:

1. Lack of liquidity.  Non-traded REITs are illiquid investments, which means that they cannot be sold readily in the market.  Instead, investors generally must wait until the non-traded REIT lists its shares on an exchange or liquidates its assets to achieve liquidity.  These liquidity events, however, might not occur until more than 10 years after your investment.

Non-traded REITs usually offer investors opportunities to redeem their shares early but these share redemption programs are typically subject to significant limitations and may be discontinued at the discretion of the REIT without notice.  Redemption programs also may require that shares be redeemed at a discount, meaning investors lose part of their investment if they redeem their shares. 

For these reasons, investors with short time horizons or who may need to sell an asset to raise money quickly may not be able to do so with shares of a non-traded REIT.

2. High fees. Non-traded REITs typically charge high upfront fees to compensate a firm or individual selling the investment and to lower their offering and organizational costs.  These fees can represent up to 15 percent of the offering price, which lowers the value and return of your investment and leaves less money for the REIT to invest.  In addition to the high upfront fees, non-traded REITs may have significant transaction costs, such as property acquisition fees and asset management fees.

3. Distributions may come from the principal.  Investors may be attracted to non-traded REITs by their high distributions, which may be referred to as dividend yields, compared to other investment options, including publicly-traded REITs.  However, the initial distributions may not represent earnings from operations since non-traded REITs often declare these distributions prior to acquiring significant assets.  Investors should consider the total return of a non-traded REIT – capital appreciation plus distributions – instead of focusing exclusively on the high distributions.  Non-traded REITs may use offering proceeds, which includes the money you invested, and borrowings to pay distributions.  This practice reduces the value of the shares and reduces the cash available to the REIT to purchase real estate assets.

4. Lack of share value transparency.  Because non-traded REITs are not publicly traded, there is no market price readily available.  Consequently, it can be difficult to determine the value of a share of a non-traded REIT or the performance of your investment.  In addition, any share valuation will be based on periodic or annual appraisals of the properties owned by the non-traded REIT, and therefore may not be accurate or timely.  As a result, you may not be able to assess the value or performance of your non-traded REIT investment for significant time periods.

5. Conflicts of interest.  Non-traded REITs are typically externally managed – meaning the REITs do not have their own employees.  As noted above, the external manager may be paid significant transaction fees by the REIT for services that may not necessarily align with the interests of shareholders, such as fees based on the number of property acquisitions and assets under management.  In addition, the external manager may manage or be affiliated with other companies that may compete with the REIT in which you are invested or that are paid by the REIT for services provided, such as property management or leasing fees.

Where Can I Get Information about a  Non-Traded REIT?

When a broker is recommending that you invest in a non-traded REIT, he or she should provide you with a copy of a prospectus.  The prospectus is the offering document that describes the investment strategy of the REIT, its offering terms,  and the risks and other information that you should consider when deciding whether to invest.  There may also be supplements to the prospectus which detail changes since the original date of the prospectus.  Before investing, you should carefully review the prospectus and any prospectus supplements before making any investment decision.  Because they are required to be filed with the SEC,  the prospectus, as well as any supplements, can also be found through the SEC’s EDGAR database usually identified as a “424B3” filing. 

Non-traded REITs that are registered with the SEC are required to file quarterly and annual reports detailing their financial results.  These reports can be found on the SEC’s EDGAR database and are identified as a Form 10-Q for a quarterly report and a Form 10-K for an annual report.  Forms 8-K may also be filed in connection with the occurrence of certain events that require disclosure.  You should carefully review these reports before investing.

Unlike publicly-traded REITs, non-traded REITs have certain characteristics making them a riskier investment.

Below is a chart comparing Publicly Traded REITS to Non-Traded REITS

Publicly traded REITs Non-traded REITs
Overview REITs that file with the SEC and whose shares trade on national stock exchanges. REITs that file with the SEC but whose shares do not trade on national stock exchanges.
Liquidity Shares are listed and traded, like any publicly traded stock, on major stock exchanges. Most are NYSE listed. Shares are not traded on public stock exchanges. Redemption programs for shares vary by company and are limited. Generally a minimum holding period for investment exists. Investor exit strategy generally linked to a required liquidation after some period of time (often 10 years) or, instead, the listing of the stock on a national stock exchange at such time.
Transaction costs Brokerage costs the same as for buying or selling any other publicly traded stock.         Typically, fees of 10-15 percent of the investment are charged for broker-dealer commissions and other up-front costs. Ongoing management fees and expenses also are typical. Back-end fees may be charged.
Management Typically self-advised and self-managed. Typically externally advised and managed.
Minimum investment amount One share. Typically $1,000 – $2,500.
Performance measurement Numerous independent performance benchmarks available for tracking listed REIT industry. Wide range of analyst reports available to the public. No independent source of performance data available.

Source: National Association of Real Estate Investment Trusts (NAREIT)

If they work as planned, non-traded REITS will experience a liquidity event when they eventually list on an exchange or are acquired in a transaction paying out cash to investors for their shares. While successful non-traded REITs will experience such a “liquidity event,” allowing for distribution to the investor, many non-traded REITs fail.

Tips to Avoid Pitfalls in Investing in Non-Traded REITs:

FINRA has published a list of tips to  help avoid some common pitfalls and misconceptions surrounding public non-traded REIT investing:

1. Do not put all your investments in one basket: Avoid putting too much of your nest egg in a single REIT or in multiple REITs of the same family. Older investors should be particularly cautious about investing large portions of their retirement income in non-traded REITs.
2. Your initial investment in a non-traded REIT is not guaranteed and may increase or decrease in value.
3. Do not invest solely based on distributions the non-traded REIT may currently be generating. Distributions can be suspended for a period of time or halted altogether. Unlike interest from a CD or bond, REIT distributions may be funded in part or entirely by cash from investor capital or borrowings—leveraged money that does not come from income generated by the real estate itself.
4. Redemption policies can change, making it extremely difficult to get money out of the non-traded REIT when you need it.
5. Think hard before deciding to reinvest any distributions, especially if you think you might need the money in the near future. Reinvested distributions are generally subject to the same redemption policies as other investments, which means they may be illiquid for significant periods of time.
6. Be wary of claims that a non-traded REIT “is about to go public.” The public offering process is often lengthy and may never come to fruition; and if it does, the REIT may trade at a price that is lower than its current valuation. Your best source of information about a non-traded REIT’s path to liquidity will be SEC filings made by the REIT itself, found on the SEC’s EDGAR database.
7. Decisions about distributions, redemptions, and “liquidity events” such as going public or selling property are made by the REIT that owns the actual real estate. Most non-public REITs have an investor relations department that can help answer questions about a REIT’s business operations, including a REIT’s redemption program. Contact the SEC if you have concerns about the REIT itself.
8. Think hard before investing any proceeds from one non-traded REIT into another, particularly if both REITs are being sold by the same securities firm. While this may be good for the sales representative, who is likely to make a commission on your investment, it may not be good for you.

Non-Traded REITs can be a good investment and are suitable for some investors. But, sometimes they are not appropriate for an individual, depending on the client’s investment objections. Your broker has the duty to ensure that this investment is suitable for you and not to make any misrepresentations (whether intentional or negligent) in selling this alternative investment.

Have you lost money in a Non-Traded REIT?

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If you or a loved one have suffered investment losses as a result of an investment in a Non-Traded REIT or have suffered any other type of investment fraud or broker negligence, contact the offices of Investment Fraud lawyer Melanie Cherdack for a free consultation. Because she has been in the trenches as a former Wall Street attorney, Melanie Cherdack and her team of experienced attorneys have seen just about every type of investment fraud or investment scam. While almost every investment carries a degree of uncertainty and risk, you may have been unnecessarily exposed to such risk. Former Wall Street securities attorney Melanie S. Cherdack and her team of lawyers represent individual and institutional investors who are unwitting victims of investment fraud and broker negligence. She heads up a group of attorneys who represent investors across the United States. Contact us by filling out our online contact form, or calling 888-768-2499 or 305-349-2336.