The new Ford Pinto – Non-traded REITs?

~ By Gerald Rome, Colorado Securities Commissioner ~

Gerald Rome

Gerald Rome

Every year, there seems to be a new financial product out there, and like a new model car, it is advertised as better than last year’s model, or last year’s investment product.  REITs, short for real estate investment trusts, have become the new model car for 2014.  REITs are by no means new financial instruments. In fact, REITs have been around since the 1960’s when President Eisenhower signed the REIT Act into law.  It enables the REIT to pool investments of numerous investors to purchase a portfolio of real estate properties, from office buildings and shopping centers to hotels and apartment buildings, which the typical investor might not be able to invest in individually.  Profits generally come from the rent charged to tenants of the property, and any increase in value of the real estate when it is sold years later.  REITs have surged in popularity in recent years due to interest rates hovering around historic lows and investors searching for higher rates of return.

There are two types of REITs: those that trade on a national exchange and those that do not. For those that are traded on an exchange, shares can easily be bought and sold at the market price.  The second set are called non-traded REITs.   As their name implies, non-traded REITs have no public trading market.  For this reason, they are generally illiquid investments, meaning that investors have a difficult time selling their shares, or getting out of the investment.  And because there is no market for the shares, there is no market price for them.  If you can find a buyer, the purchase price is usually at a substantial discount to what you purchased the shares for.  For these reasons, for some investors, the non-traded REIT may be the new version of the Ford Pinto, or the Chevy Corvair, or maybe even the AMC Pacer.  We remember how all those “new” models turned out.  For this reason, investors should be particularly cautious when dealing with non-traded REITs.  Here are some of tips:

  • Avoid putting too much of your nest egg in a single REIT or in multiple REITs of the same family. Older investors should be cautious about investing large portions of their retirement income in non-traded REITs.
  • Your initial investment is not guaranteed and may increase or decrease in value.
  • Early redemption – selling your shares back to the REIT – is often restrictive and may be expensive.
  • Distributions can be suspended or halted altogether, and REIT distributions may be funded by cash from investor capital or borrowings – leveraged money that does not come from income generated by the real estate itself.
  • Fees can add up.  Front end fees, what you pay when you purchase the shares, can be as much as 15% of the per share price.
  • Non-traded REITs are rarely, if ever, suitable for short term investors and even long term investors must be willing to bear the risks of illiquidity.

As always, the best way to protect yourself as an investor is to be vigilant, research the investment, ask questions, and contact a regulator if you have any concerns. The Colorado Division of Securities can be reached at 303-894-2320.

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