Real Estate Investment Trusts, or REITs, come in all shapes and sizes. Some choose to focus on a sub-sector of the real property market like multifamily, while others take a much broader approach. In addition to their differing focuses, some REITs choose to trade on major stock exchanges while others are non-traded. These non-traded REITs, which can either be open to the public or private, have pros and cons compared to their publicly traded peers. Here's a look at the case for and against investing in a non-traded REIT.
What are non-traded REITs?
The two types of non-traded REITs are public non-traded and private non-traded.
Public non-traded REITs, like their publicly traded peers, are open to anyone who has money to invest, though many have a minimum investment requirement. However, instead of trading on major stock exchanges like the Nasdaq or New York Stock Exchange, investors need to purchase shares either directly from the REIT's management company -- such as through its real estate crowdfunding platform -- or a third-party broker-dealer. Non-traded REITs must still register with the Securities Exchange Commission (SEC) and file quarterly and annual reports like publicly traded REITs.
Private non-traded REITs, on the other hand, aren't available to the general public, nor are they required to register with the SEC. They're typically only available to accredited investors, which are those who either have a high net worth of more than $1 million (excluding their primary residence) or have high incomes of at least $200,000 annually over the last two years. Further, they often have high minimum investments and large upfront costs.
The pros of investing in non-traded REITs
Non-traded REITs have three main advantages over publicly traded ones:
- Their value and dividend yield doesn't fluctuate with the stock market. Whereas the price and yield of publicly traded REITs change with each trade, the value and yield of a non-traded one typically only resets once each quarter.
- Instead of changing hands at the going market price -- which is often influenced by investor sentiment rather than underlying value -- non-traded REITs sell shares based on their net asset value (NAV), which is the total value of its assets minus liabilities. Because of that, investors buy shares based on the actual value of the real estate instead of at the market price, which can be at a significant premium or discount to the NAV.
- Non-traded REITs typically have long holding periods, often more than a year. This requirement helps align investors with the company's long-term strategy.
These characteristics enhance a non-traded REIT's ability to create value for its investors over the long term. Investors in publicly traded REITs run the risk of buying at a high premium due to short-term market euphoria or selling at a deep discount if they're unnerved by a stock market sell-off. Investors in non-traded REITs, on the other hand, can buy shares at its NAV and typically must hold them for at least a year. As such, they're more likely to benefit from the ability of the underlying income-producing properties that REITs invest in to create long-term wealth.
The cons of investing in non-traded REITs
While non-traded REITs have several benefits, they also have their drawbacks. Here are four big ones:
- They lack liquidity. Whereas an investor can easily buy and sell shares of a publicly traded REIT, it's much harder to monetize an investment in a non-traded one. Many have a required holding period ranging from one to 10 years. While some do offer repurchase programs during that time frame, they often come at a discount to the NAV. This lack of liquidity can prove problematic if an investor needs the cash before the end of the required holding period.
- They typically require a high minimum initial investment along with sizable subsequent ones. Investors usually need to invest between $1,000 and $5,000 in a public non-traded REIT with subsequent purchases made in increments of at least $500. Private non-traded REITs, meanwhile, usually require a minimum investment of $10,000 to $100,000. For comparison's sake, many investors can buy as little as one share of a publicly traded REIT, which typically cost between $10 to $100 apiece. The high upfront investment required for most non-traded REITs puts them out of reach for many beginning investors.
- The fees can add up. Non-traded REITs have historically charged investors an upfront fee of as much as 15% of their initial investment. As a result, investors started from a deep hole. Crowdfunded REITs, however, have brought down that cost, with most charging less than 3%. Though in a world where investors don't pay any commission to buy shares of a publicly traded stock, the upfront costs of investing in non-traded REITs are much higher, which can eat into an investor's return.
- They’re not as transparent as publicly traded REITs. Because private non-traded REITs aren’t required to file updates with the SEC, many leave their investors in the dark when it comes to their financial performance. In addition to that, non-traded REITs lack value transparency since their share prices only update quarterly or annually. Because of that, investors might not receive full value when they sell.
For many investors, the pros of non-traded REITs outweigh the cons
Non-traded REITs come with their share of trade-offs compared to their publicly traded peers. However, these differences, even the cons, often make them appealing options for investors who want to buy a portfolio of commercial real estate. That's because non-traded REITs enable investors to diversify their portfolio outside of the stock market. Further, they can potentially earn higher returns over the long term since they can purchase shares at the NAV instead of at a premium. That's why non-traded REITs -- especially public crowdfunded ones -- can be a worthwhile consideration for investors.
However, investors need to be extra cautious when it comes to investing in non-traded REITs so that they don’t end up stuck in a bad investment or falling for a REIT scam. Doing thorough due diligence is a must, which includes finding out everything you can about those who are managing the REIT as well as reading through all the available information.