On October 4, the Financial Industry Regulatory Authority (FINRA) — the agency which handles securities arbitration — released a new Investor Alert titled “Public Non-traded REITs — Perform a Careful Review Before Investing.” The purpose of this alert is to aid investors in understanding the risks, benefits, fees and features of non-traded REITs, or real estate investment trusts.
According to FINRA’s press release on the alert, “While investors may find non-traded REITs appealing due to the potential opportunity for capital appreciation and the allure of a robust distribution, investors should also realize that the periodic distributions that help make non-traded REITs so appealing can, in some cases, be heavily subsidized by borrowed funds and include a return of investor principal.” The press release goes on to say that non-traded REITs usually carry a very limited redemption of shares, as well as high fees and an eroded total return.
REITs purchase a portfolio of properties by pooling the capital of many investors. REITs can involve a variety of properties including hotels, office buildings, apartments and timber-producing land. The alert concentrates on REITs that do not trade on a national securities exchange, as opposed to those that do.
The trouble with Public Non-traded REITs:
- There is no guarantee for distributions. Distributions can exceed operating cash flow and can be suspended for a certain length of time or stopped completely.
- Valuation complexities and illiquidity can be created if there is a deficiency of a public trading market. Furthermore, non-traded REITs’ valuation can be affected by many factors, including the trust’s balance sheet strength, cost of capital, overhead expenses and the portfolio of assets owned.
- If an investor wants to redeem the investment early, this is often expensive and restrictive. Furthermore, early redemption pricing is usually lower than the purchase price.
- State and FINRA guidelines help to limit front-end fees by restricting them to 15 percent. However, this means that only 85 percent of the total investment is working for the investor, making non-traded REITs expensive.
In addition to the information about public non-traded REITs, FINRA’s Investor Alert also provides extremely helpful information about private REITs, which do not trade on an exchange and they are generally not subject to Securities Act registration. Because of the lack of disclosure documents, it is very hard for investors to make informed decisions about this type of investment. The full Investor Alert is available on FINRA’s website and is a very useful tool for investors considering public non-traded REITs.