Unlisted or "private" real estate investment trusts (REITs) have caused a number of problems for investors and regulators in recent years.
Unlike their publicly traded cousins, private REITs are sold through brokers to yield-hungry investors who are told that their high yields and prices won't change. REITs own properties ranging from apartment buildings to shopping malls and hold them in large portfolios. Private REITs often make money when they either sell the properties -- a difficult proposition in today's market -- or go public.
So those weary of pathetic 1-percent certificates of deposit jumped at these vehicles. They're backed by real estate, so aren't they safe?
Most of the difficulties with private REITs have centered on poor transparency, high fees and net asset values that may have dropped significantly from what brokers' promised. Once you get into a private REIT, you may not be able to get out for years or by paying a steep penalty, so they are extremely illiquid. And with front-end fees of up to 15 percent, they are among the most expensive vehicles to own.
FINRA, the securities industry regulator, has known about and issued occasional warnings over the past few years and is reportedly considering a wider crackdown on private REITs. It will be long overdue. It's already cited David Lerner & Associates, a leading private REIT marketer, for violations of FINRA suitability rules.
When I looked at these investments
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a few months ago, I discovered that prospectuses are loaded with multiple layers of fees and it's incredibly difficult to find how much you're actually paying to own them.
This is what FINRA had to say about REITs in an investor alert issued late last year:
"Be wary of pitches or sales literature offering simplistic reasons to buy a REIT investment. Sales pitches might play up high yields and stability while glossing over the product’s lack of liquidity, fees and other risks. Ask whoever is recommending that you purchase a REIT how much they (and their company) are receiving in selling commissions or other fees. Also ask them to explain why they think the REIT is the right investment for you and how will it help you achieve your specific investment objectives and goals.1
Always ask to review the initial prospectus and any prospectus supplements, as these documents will contain a more extensive and balanced discussion of the risks involved than any sales material you receive or pitches you hear. You can obtain a prospectus by going to the SEC’s EDGAR database of company filings and typing in the name of the REIT, then search for entries titled “Prospectus.” Remember that the fact that a company has registered its securities or has filed reports with the SEC does not mean that it will be a good investment—or that it will be right for you.
Ask about fees associated with the product. Also ask how the distribution is being funded and whether a portion of that distribution is comprised of a return of investor capital. Make sure you understand that you will be locking up your investment, with only limited avenues for redemption. If the REIT offers a share redemption program, make sure you understand how the repurchase price for your shares will be determined and, most importantly, the limitations of the plan. Review with your financial professional the risks associated with real estate investment and evaluate other products that could meet your investment objectives (investment income, for instance). Understand the various liquidity events specific to the REIT you are considering."
After analyzing several private REITs, my conclusion is that you are better off owning a publicly traded mutual fund or exchange-traded fund that owns a number of REITs in a large, managed portfolio. The expenses are transparent and a fraction of what brokers are charging for the unlisted products. You'll also get much more exposure to properties across the world.
