For years investors have asked the question: “Is it better to invest in traded or non-traded REITs?” While both invest in commercial real estate and related assets, they are designed with different objectives in mind and behave differently. Both types of investments have a place in a well-balanced and diversified portfolio.
Created by Congress in 1960, a REIT is a company that combines the capital of many investors to acquire or invest in commercial real estate and related assets. Through the purchase of shares of stock, stockholders are able to invest in a professionally-managed portfolio of commercial real estate that they might not have been able to purchase otherwise. One important feature of all REITs is that they must pay at least 90 percent of their REIT taxable income to stockholders in the form of distributions on an annual basis; therefore they potentially provide a consistent stream of income to investors.
Both public non-traded and traded REITs have a place in a
well-balanced and diversified investment portfolio.
Benefits of Adding REITs to an Investment Portfolio
Current Income: The leasing of high-quality commercial real estate is generally designed with the objective of providing investors with a recurring stream of income since long-term leases, which are typical in many commercial real estate sectors, may provide predictable cash flow. A REIT then pays out distributions on a monthly or quarterly basis; however, the actual amount and timing of distributions is not guaranteed and the distribution rate depends on the amount of funds available. There is no assurance that a recurring income stream will be generated or will continue, and there can be no guarantee that these objectives can be met.
Potential Hedge Against Inflation and Opportunities for Growth: As the economy improves, prices of goods and services will likely increase, and commercial real estate can benefit. A REIT that is actively acquiring income-producing properties can give stockholders a unique opportunity to participate in property value appreciation as well as rent increases, which are generally built into long-term leases in the retail, office and industrial sectors. These rental revenue increases may provide a hedge against inflation.
Tax Benefit: Typically, a REIT is not subject to federal corporate income tax as long as it pays distributions to its stockholders of at least 90 percent of its REIT taxable income, thus eliminating “double taxation” (taxation at both the corporate and stockholder levels).
Diversification: Investing in a REIT can help smooth risk and diversify a portfolio for investors. A second layer of diversification can be achieved within the REIT itself if it is diversified by property type, location, tenant, industry and/or lease term. However, there is no assurance that a diversified portfolio will be created or that such a portfolio will provide greater benefits to stockholders than a portfolio that is more concentrated in any particular individual real estate investment sector or location.
Transparency: Traded and public non-traded REITs are required to file financial reports with the United States Securities and Exchange Commission (SEC).
Professional Property Management: Individuals can invest in an entity that owns high-quality, commercial real estate assets which are run by professional managers that acquire and maintain the properties.
Comparing REITs
Non-traded and traded REITs are important investments to consider adding to a well-balanced and diversified portfolio. Over the long-term, investors should expect to generate income and may experience growth. As with all investments, there can be no guarantee that these objectives can be achieved or maintained.
| Non-Traded REITs | Publicly Traded REITs | |
|---|---|---|
| Description | Registered with the SEC; Not traded on an exchange; Suitable only for investors who have adequate financial means, desire a relatively long-term investment and will not need immediate liquidity; Available for purchase through a financial advisor. | Registered with the SEC and traded on an exchange; Available to any person or entity with a brokerage account.* |
| Investment Objective* | Current income and eventual capital appreciation.* | Current income and share price appreciation.* |
| Share Price | Share price typically remains unchanged during offering period, and typically the value of the shares is estimated within 18 months after the end of the initial public offering and every year following until a liquidity event, at which time the value may change. | Limited, interim liquidity may be available through a share repurchase program. Typically non-traded REITs aim to provide ultimate liquidity through a stock exchange listing, merger, or sale of the assets.Shares are priced by the trading market, which causes a company’s stock to fluctuate daily based on factors such as supply (number of sellers) and demand (number of buyers) |
| Liquidity | Limited, interim liquidity may be available through a share repurchase program. Typically non-traded REITs aim to provide ultimate liquidity through a stock exchange listing, merger, or sale of the assets. | Ongoing liquidity as shares can be sold on an exchange at any time. |
| Time Horizon | Mid-to long-term investment; typically ranges from 5 to 10 years. | Short- to long-term investment depending on when investor purchases and sells shares. |
| Benefits | Income and growth potential; portfolio diversification; smooth portfolio risk; diversification away from daily stock market volatility; inflation hedge; protection against investment decisions based on emotions. | Income and growth potential; portfolio diversification; inflation hedge; liquidity. |
| What to look for when evaluating a REIT | The source of funds used to cover the distribution; Quality and depth of the management team; Business plan; Debt level | |
* Investment Program Association, “Guide to Understanding REITs.”
Disclosure
This is neither an offer to sell nor a solicitation of an offer to buy any security, which can be made only by a prospectus, which has been filed or registered with appropriate state and federal regulatory agencies and sold only by broker dealers authorized to do so. An offering is made only by means of the prospectus in order to understand fully all of the implications and risks of the offering of securities to which it relates. A copy of the prospectus must be made available to you in connection with any offering.
The views expressed herein are subject to change based upon economic, real estate and other market conditions. These views should not be relied upon for investment advice. Any forward-looking statements are based on information currently available to us and are subject to a number of known and unknown risks, uncertainties and factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements.
Important Risk Factors to Consider
Some of the risks related to investing in a non-traded REIT include, but are not limited to:
- The board of directors, rather than the trading market, determines the offering price ofshares; there is limited liquidity because shares are not bought and sold on an exchange; repurchase programs may be modified or terminated; a typical time horizon for an exit strategy is longer than five years; and there is no guarantee that a liquidity event will occur.
- Distributions cannot be guaranteed and may be paid from sources other than cash flow from operations, including borrowings and net offering proceeds. Payments of distributions from sources other than cash flow from operations may reduce the amount of capital a REIT ultimately invests in real estate assets and a stockholder’s overall return may be reduced.
- Failure to qualify as a REIT and thus being required to pay federal, state and local taxes, which may reduce the amount of cash available for distributions.
- Principal and interest payments on borrowings will reduce the funds available for other purposes, including distributions to stockholders. In addition, rates on loans can adjust tohigher levels, and there’s a potential for default on loans.
- Conflicts of interest with, and payments of significant fees to, a business manager, realestate manager or other affiliates.
- Tax implications are different for each stockholder. Stockholders should consult a tax advisor.
- Commercial real estate market risks such as local property supply and demand conditions, tenants’ inability to pay rent; tenant turnover; inflation and other increases in operating costs; adverse changes in laws and regulations; relative illiquidity of real estate investments; changing market demographics; acts of God such as earthquakes, floods or other uninsuredlosses; interest rate fluctuations; and availability of financing.
Publication Date: 07.15.2013
