High fees and a lack of liquidity are just two reasons that non-traded REITs are in the hot seat with the Financial Industry Regulatory Authority (FINRA). Yesterday, the regulator issued an alert to investors, outlining the potential drawbacks and risks that non-traded REITs contain.
Non-traded REITs do not trade on a national exchange, are generally illiquid and sold exclusively through independent broker/dealers. In addition, early redemption of shares in a non-traded REIT is extremely limited, and commissions for non-traded REITs can be as high as 15%. By comparison, front-end underwriting fees in the form of a discount may be 7% or more of the offering proceeds for exchange-traded REITs.
Despite these drawbacks, non-traded REITs have become increasingly popular in recent year, as investors search for alternative investment vehicles that can offer high yields. As reported Oct. 4 by Investment News, investors bought close to $4.6 billion in non-traded REITs through June 30.
In September, FINRA issued a rule proposal aimed at changing how the value of non-traded REITs appear on client account statements, as well as brokers’ commissions and other upfront costs.
FINRA’s recent investor alert on non-traded REITs outlined several issues with the products, including the fact that the periodic distributions that help make non-traded REITs so appealing can, in some instances, be heavily subsidized by borrowed funds and include a return of investor principal. This is in contrast to the dividends investors receive from large corporations that trade on national exchanges, which are typically derived solely from earnings.
Lack of a public trading market creates illiquidity and valuation complexities. As their name implies, non-traded REITs have no public trading market. However, most non-traded REITS are structured as a “finite life investment,” meaning that at the end of a given timeframe, the REIT is required either to list on a national securities exchange or liquidate, says FINRA.
Moreover, even if a liquidity event takes place, there is no guarantee that the value of your investment will have gone up-and it may go down or lose all its value. Indeed, valuation of non-traded REITS is complex. Many factors affect the pricing, including the portfolio of real estate assets owned, strength of the trust’s balance sheet (assets versus liabilities), overhead expenses, cost of capital and more. The boards and managers of non-traded REITs might even rely on third-party sources to estimate a per-share value.
Finally, properties may not be specified in a non-traded REIT. Most non-traded REITS start out as blind pools, which have not yet specified the properties to be purchased. Others may specify a portion of the properties the REIT plans to acquire, or they may be in various stages of acquisition.