Why I Hate Non-Publicly Traded REITS

Posted on August 13, 2024 by Dr. David Edward Marcinko MBA MEd CMP™

On Product Frustration

Lon JefferiesBy Lon Jefferies MBA CFP® CMP®

As my experience in the financial planning and investment advisory industries has grown over the years, there is one investment that I’ve seen no logical reason to own — non-publicly traded real estate investment trusts.

Josh Brown, one of my favorite analysts and author of TheReformedBroker.com nailed each of my frustrations with these products. Here is a significant excerpt from his post:

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I consider non-traded REITs or nREITS to be part of the group of investments that are just absolute murderholes for clients – they pay the brokers so much that they cannot possibly work out (and they rarely do without all kinds of aggravation and additional costs). Further, I have yet to hear a single credible explanation as to why a broker would recommend a non-traded REIT over a public REIT other than compensation. The only explanation that makes sense to me is that 7% is a lot more than the 1% commission you get doing an agency trade on a NYSE-traded REIT. A reader with experience in the industry sent this to me and I found it hilarious. Below, a fictional, transparent conversation between an indie broker and his “client” that would never occur…

If Brokers Were Transparent:

Rep:

Before we wrap up our quarterly portfolio review I would like to talk to you about a new investment I think you might be interested in.  You have been looking for more income and this is an investment vehicle that pays a 7% dividend.

Client:

Sounds great, give me the details.

Rep:

With your portfolio size and risk tolerance I would recommend a $100,000 investment.  Given that amount let’s first go over the fees. If you invest $100,000 I will be paid a commission of $7,000. My firm is going to get $1,500 – $2,000 in revenue share. My wholesaler, the salesman that works for the investment’s sponsor company, will get $1,000. He is a great guy, buys me dinner and takes me golfing. The sponsor company is going to get around $3,000 to pay for some of the costs they incurred in setting up the investment. So after Day 1 there will be around $87,000 left over to actually invest.  I bet you are getting excited.

Client:

Are you on drugs? Why would I pay 13% in fees on anything?

Rep:

Don’t worry, it won’t feel like you are paying $13,000 in fees. The rules allow my firm to report your investment at $100,000 on your statement. You never really know what its worth but you will think you never lost money. Pretty sweet huh?

Client:

You have to be kidding.

Rep:

No, this is a really good investment. Let me tell you about the income component before you jump to any conclusions. Like I said this investment pays a 7% dividend and the dividend won’t change.

Client:

That sounds high and how do you know it won’t change?

Rep:

You see, the sponsor just picks the 7% dividend number out of thin air. Here’s how it works. You see the vehicle you are going to invest in is new and it’s going to take the firm a while before your net $87,000 is actually invested. Later on, maybe 2-4 years from now they will have the money fully invested and it will generate actual cash flow. So they just pay a quarterly dividend of 7% by giving you your money back. This is great from a tax perspective because return of capital isn’t taxed as income.

Client:

Are we on hidden camera or something?

Rep:

Ha, you are funny. I bet this next benefit will change your mind.

Client:

I hope so or I should start looking for another financial advisor.

Rep:

This is the best feature. You can’t sell your investment until the sponsor has the opportunity to create liquidity. You might be locked up in this investment for 7-10 years.

Client:

This feels like the Twilight Zone. Your firm allows you to sell this crap?

Rep:

Oh yeah, our firm sells a ton of it. In fact independent broker dealer firms like mine sold over $20 billion of these investments in 2013. Think about that. Reps like me made over $140 million dollars and our firms pocketed $20-$30 million.

Client:

This is crazy, what is this investment?

Rep:

Non-traded REITs. $100,000 sound about right?

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Currency

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Josh touched on every part of these investments that I despise — excessive commission paid to the so-called “financial advisor” (salesman), a supposed “dividend” that is really just paying the investor his own money back (essentially providing an interest-free loan), and a complete lack of liquidity and transparency.

When I begin working with a new client who owns one of these products, it is impossible to obtain accurate, current information on the investment (not even a true value is apparent). Even worse, if the client wants to sell the investment he would need to do so at pennies on the dollar. For the most part, once an investor purchases one of these products he just needs to forget about it and hope that one day he can get his money back.

Assessment

The bottom line is that if your advisor ever recommends a non-publicly traded REIT, I’d strongly recommend you walk out the door and start searching for a true financial advisor with a fiduciary responsibility to act in your best interest.

Conclusion

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4 Responses

  1. Lon Jefferies MBA CFP®, on March 4, 2015 at 11:57 AM said:

    The Best Investment of the Last 50 Years

    Any guesses what the most profitable stock since 1968 might be? The company must have revolutionized the world. Perhaps an innovative product like computers or a cure for a deadly disease.

    http://networthadvice.com/Best-Investment-of-Last-50-Years?utm_source=Mar+2015+Lon&utm_campaign=Lon+Mar+Newsletter&utm_medium=email

    Maybe a company that started in a garage and became a worldwide necessity. Possibly a company that has changed the way we live over and over again?

    Lon Jefferies MBA CFP®

    Like

  2. Ernie, on March 25, 2015 at 12:27 AM said:

    Enter the Zombie REITs

    Inland American Real Estate Trust Inc. is the kind of property company that gives some investors bad dreams. It raised $7.9 billion to buy assets it now can’t or won’t sell.

    http://www.msn.com/en-us/money/realestate/property-investors-latest-horror-zombie-reits/ar-AA9WSwx?ocid=iehp

    Now, the value of its holdings has plunged 60%. It has cut its dividend by three-quarters.

    Ernie

    Like

  3. Rick Kahler MS CFP®, on February 22, 2016 at 9:49 PM said:

    ON PRIVATE REITS

    Real estate is one of the asset classes I recommend including in a diversified portfolio. For many small investors, the best way to hold real estate is through a REIT, or real estate investment trust.

    So far, so good. But some REITs are about as appealing as a condemned apartment house beside a railroad track. I’m talking about high-cost private REITs.

    First, a little background. REITs can only invest in real estate or mortgages. The majority of REITs only own real estate; most own scores of different classes of property including residential, commercial, and hospitality properties. This makes them a simple and safe way for small investors to add a diversified investment of real estate to their portfolios. Another advantage of REITs is that they must annually distribute almost all of their rental and capital income as dividends to shareholders, which results in some favorable tax benefits.

    There are two ways to purchase shares of a REIT. The most popular is by buying shares of a REIT that is publicly traded on an exchange. Like any share traded on an exchange, this makes them very liquid and transparent. When you buy traded REITs, you know what they own and you can analyze their track records.

    The second way is to purchase shares of a nontraded or private REIT. It receives the same tax treatment as those publicly traded, but that is where most of the similarities end. A private REIT actually looks and smells more like a limited partnership. Usually, all the money needed for the investment is raised on the front end. Since the shares are not listed on an exchange, once you are in it’s very hard to get out. You often don’t know the full extent of the properties the REIT will purchase, and they often are not as diversified as their publicly traded cousins. Of course, a private REIT has no track record.

    Why would anyone want to buy a private REIT? Ask a broker who sells them, and you will get a laundry list of the benefits, like stable pricing and higher dividends, so enticing you will wonder why anyone wouldn’t buy.

    But private REITs are sold, not bought. They can pay up to 12% in marketing fees and commissions to the brokers that sell them. Public REITs pay no commissions.

    Aside from the high cost, maybe the biggest reason to avoid private REITs is that they grossly underperform public REITs. According to an article in ThinkAdvisor.com by Michael Finke, a 2014 report by an independent REIT rating publication called Green Street Advisors concluded that privately held REITs underperformed publicly traded REITs by about 3.6% per year.

    According to Finke, “The darker side is that these products contain many opportunities for sponsors to take advantage of the lack of transparency that exists within the industry. High commissions erode shareholder value. Lack of management oversight can lead to excessive fees and the purchase of property for which there are frightening conflicts of interest. There is an abundance of horror stories of nontraded REITs gone bad in which dividends have been sliced, property values have plummeted either from bad markets or abuse, and investors are left with no ability to sell even their nearly worthless shares.”

    Finke also quotes Green Street Advisors co-founder Jon Fosheim as saying sponsors may view private REITs as a way to “charge outrageous fees, have plenty of conflicts that we can exploit, and no one will know the difference because we won’t list on an exchange.”

    Given these drawbacks, I am not willing to gamble even the smallest portion of my retirement portfolio on a private REIT.

    Rick Kahler MS CFP®

    Like

  4. JOE, on February 23, 2021 at 5:59 PM said:

    PUBLIC REITS

    This is a perfect explanation as to why I think these are rarely going to be an investment vehicle that I recommend to clients.

    When you really start looking under the hood as to how these work it’s hard to believe that they’re legal. I know these are typically slotted for accredited investors or more high net worth clients but unless they’re not paying attention I’m not seeing the attractive part of this if you’re not benefiting from the commission.

    JOE

    Like

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