Investing in Non-Traded REITs: Liquidity Concerns and Lack of Oversight Highlight Major Risks for Investors

By Franco Piccinini

Non-traded REITs offer unique investment opportunities for highly sophisticated, well capitalized investors, but they can present significant risks for average investors. In order to mitigate losses, investors should understand those risks before investing in a non-traded REIT.

What is a REIT?

So, you want to invest in real estate, but you lack the capital and expertise required to purchase and manage a rental property of your own: what can you do? You might consider investing in a REIT. A REIT—or real estate investment trust—can provide an accessible vehicle for everyday investors to place their capital in real estate. In short, a REIT is a company that owns, and often manages, real estate assets on behalf of a group of investors. REITs fund the purchase of real estate by pooling investor capital into one fund and then using that capital to target certain classes of real estate.

Often, REITs focus on specific asset classes. There are residential REITs, office REITs, industrial REITs, and hospitality REITs, to name a few. REITs offer attractive investment opportunities because they allow ordinary people to invest in real estate without having to wade into the complexities of construction, financing, or managing of real estate.

Publicly Traded REITs vs. Non-Traded REITs: Distinguishing Characteristics

Yet, not all REITs are created equal. Generally, REITs fall into two distinct categories: publicly traded REITs and non-traded REITs. Notably, publicly traded REITs list their shares on a public stock exchange, allowing for a secondary trading market. This feature means that shares of publicly traded REITs are often liquid, and most investors purchase them with the hope that the value of their shares will appreciate over time. Even publicly traded REITs have risks. On the other hand, non-traded REITs do not list their shares on a public stock exchange, so they possess a very limited secondary trading market. This limited market makes shares of non-traded REITs highly illiquid, meaning that investors cannot easily sell their investment. As opposed to capital appreciation, investors often purchase non-traded REITs to earn income from dividends. But dividends from non-traded REITs are typically funded from new share purchases or debt, meaning that even the dividends initially offered may dry up over time.

Notable Risks and FINRA Warnings & Tips

In addition to the lack of liquidity and precarious source of distributions, non-traded REITs often charge high fees upfront—sometimes as much as 15% of the offering price—which significantly lowers the return of investment. Moreover, as opposed to publicly traded REITs, it is not uncommon for non-traded REITs to solicit new investments before actually purchasing any real estate. This means that investors often cannot accurately assess the risks of any given non-traded REIT, since the risk profile for any given class of real estate may vary. To make matters worse, neither FINRA nor the SEC monitor the selection of assets by non-traded REITs. Instead, those entities police the brokers who sell non-traded REITs and rely on investors to read the mandatory disclosures.

In response to these risks, FINRA has published several tips for investors considering investing in non-traded REITs: (1) understand the source of funding for the REIT’s distributions, (2) understand that your shares will likely be illiquid, (3) expect high fees, and (4) read the prospectus to understand the REIT’s borrowing policy and to determine whether the REIT has yet to purchase any real estate.

In short, investors should exercise caution and conduct significant due diligence before investing in non-traded REITs.