Non-Traded REITs – Warning, Danger Ahead

Are you looking for income? One solution often pitched is private and non-traded REITs (real estate investment trusts). REITs raise money to buy income-producing real estate. In this low-yield environment, they are touted as having high yields and no market risk, and as alternatives to bonds.

House on moneyThese days, REITs are selling like hotcakes. According to Investment News, sales doubled to $20 billion in 2013 from a year earlier. Sales were likely to be robust for 2014 as well, though the Wall Street Journal reports that they may be down a bit when final numbers are available.

Here are a few things to consider before taking the leap. First, these investments have been criticized for very high fees and aggressive sales tactics. Advisers selling REITs often profit by taking as much as 10 percent of the sales proceeds. Other fees also reduce your returns.

Next, unlike with bonds, distributions are not guaranteed. The REIT can decide to reduce payouts, whereas a company cannot typically reduce a bond payment short of bankruptcy. In fact, many of the largest non-traded REITs have lowered their income distributions.

Finally, the promise of no market risk comes from an illusion, because you can’t look up the price every day. Not being able to see a daily price is very different from having no market risk. In fact, many non-traded REITs have lost value compared with publicly traded REITs, which have gained about 131 percent over the past five years ending Jan. 9, as measured by the Vanguard REIT index Fund (VGSLX). In addition, the index fund is easy to sell, while non-traded REITs are far less liquid.

I warned against non-traded REITs last year in AARP The Magazine as one of several bad money moves. I’m not alone in that opinion. FINRA, the industry’s self-funded regulator, has issued an investor alert. FINRA warns that these products are illiquid and expensive, while the high income distributions can be heavily subsidized by borrowed funds and, in part, be merely a return of the investor’s own principal. The Investment Program Association (IPA), however, believes these investments provide “potentially higher than average income” and “portfolio diversification.”  The 144 members of the advocacy group include issuers of non-listed REITs.

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My advice is to be very skeptical if someone promises you returns that are safe and high. This is true whether it’s a non-traded REIT or any other investment. While such investments may exist, they are quickly snapped up by institutional investors. Less attractive investments pay high commissions to pitch to consumers. Look very carefully before you leap.

Photo: DMU59/iStock

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