REITs – what you need to know before investing
REITs – Real Estate investment Trusts involve approximately 3.5 trillion in gross real estate assets, according to Nareit data. 44% of American households invest in REITs in their 401k plans and other investments.
What is a REIT?
REITs are corporations that own a portfolio of large scale real estate properties such as hotels, apartments, office buildings, shopping centers, data centers, warehouses, medical centers, storage facilities, senior living centers, student housing, mortgages and mortgage-backed securities.
By investing in REITs, investors can earn a share of income from commercial real estate investments, but they do not have to actually purchase any commercial real estate property or worry about managing it.
How many types of REITs?
There are 3 main types of REITs: publicly traded REITs, non-traded REITs or non-exchange traded REITs and private REITs.
Publicly-traded REITs
Publicly traded REITs are registered with the U.S Securities and Exchange Commission (SEC) and are publicly traded on the security stock exchange. Therefore, investors can easily trade them like stocks. Investors can trade equity REITs as individual stocks, mutual funds, and exchange-traded funds.
Non-traded REITs
Non-traded REITs are registered with the SEC, however, they are not publicly traded on the stock exchange. Therefore, investors cannot buy and sell them as easily as publicly traded REITs, but can purchase them through brokers or financial advisors participating in non-traded REITs offerings. Non-traded REITs have redemption restrictions where shares need to be held for a certain period before they can be redeemed.
Private REITs
A private REIT is not publicly traded. Unlike publicly traded REITs and non-traded REITs that have regular SEC disclosures such as prospectus, annual reports (10-K), quarterly reports (10-Q), private REITs are not subject to those SEC disclosures and have some exemptions from SEC registrations. In addition, private REITs can be sold only to accredited investors through brokers. For instance, any individual that has a net worth exceeding $1,000,000 or earns an annual income of over $200K is considered an accredited investor. Brokerage expenses may include items such as fees, management costs, profit percentages and may vary from company to company.
Differences between publicly traded REITs and non-traded REITs
| Publicly traded REITs | Non-traded REITs | |
| SEC registration | registered with the SEC | registered with the SEC |
| Listing | Publicly traded REITs are listed on the security stock exchange | Non-traded REITs are not listed on the stock exchange |
| Secondary market offerings | Since publicly traded REITs are listed on the national security stock exchange, investors can trade them easily. | Since non-traded REITs are not listed on the stock exchange, they have an investment and redemption limitation for investors. |
| Front-end fees | Under-writing fees may be 7% or above of the offering proceeds. | Fees can be up to 15% of the per-share price. |
| Return on investment | Return on investments generally is capital appreciation on share price. Dividends may also be paid to investors. | High dividends over a period of several years are paid to investors.Capital return on liquidation may be more or less than the original investment. |
What is the return of REITs?
Return of REITs
Following is the total return on average of Nareit All REITs compared to the return of S&P 500 over the last 25 years.
Souce: Nareit and Slickcharts
Return of different REIT sections
There are multiple REIT sections. Following is the total average return for various REIT sections such as office, industrial, retail, residential, healthcare, lodgings/resorts, storage units and mortgages over the last 25 years.
Souce: Nareit and Slickcharts
Risks of investing in non-traded REITs
Dividends may fall into default or suffer devaluation
Non-traded REIT investors may be attracted to its high dividend yield. However, the risk of distribution default or devaluation should be highly concerning because increasing distributions can be made from the proceeds of selling new shares or the leverage from borrowing funds. This can result in the loss of investment when a liquidity event needs to take place.
Redemption restriction and liquidity may carry risks
Non-traded REITs limit the amount of shares that can be redeemed before the liquidity event. Investors may have to hold for some period, typically 1 year before shares can be redeemed. Redemption price may be lower than the purchased share price by up to 10%.
After a certain period, non-traded REITs are required to either list on the national security exchange or liquidate. When liquidity takes place, investment can go up or down. Investors may lose part of their investment or the entire investment.
Per-share value may be a not a true price
REIT’s share value relies on a third party’s valuation methodologies to estimate its value per share. The per-share price is estimated based on many factors such as the pool of real estate properties, the health of the entity’s assets vs liabilities, costs of capital and so on. There is no guarantee that the estimation reflects its true value. Therefore, investors may pay a per share price above or below its per share net value.
Pools of property investment may lack of transparency
Some real estate properties in the pool may not be specified because they are in different stages of acquisition. It may cause risks to investors.
How to minimize the risk of REIT investment
Seeking information about share price valuation
Before investing in REITs, investors should do research on how the share price was valued to avoid overpaying. If the REIT’s investment portfolio has dramatically changed during the period of offering shares, the share price can highly fluctuate. As a result, the share price can be overvalued or undervalued.
Understanding REIT’s leverage and borrowing policy
Investors should figure out how much of borrowed funds or proceeds from selling new shares are included in the distributions. Investors can use the SEC’s data to check how much leverage an entity has. Distribution information is also available in the company’s financial activities for investors to review. If distributions are larger than the company’s net cash earned through real estate investment, distributions may include other sources such as borrowing funds.
Researching REITs redemption period and liquidity
Investors should review REITs’s prospectus disclosures. Do research to figure out how long shares have to be held before they can be redeemed. Also, there is risk associated with potential liquidity.
Be aware of investing in ‘Mini tender” offers. Mini tenders outside of the sponsor redemption program usually offer under 5% of the company’s stocks and do not provide sufficient disclosures about their filings with the SEC, information about the offers and investors’ protections as well as the company. However, as smart investors, you should be careful with those mini tenders. In many cases, mini tender offers sound more attractive, but investors lacking solid information may be stuck in situations when they cannot withdraw the offers and have to sell shares under the market price. Therefore, before offering your shares, ensure that you have important information about the bidders, their disclosures, the market share price and so on.
Understanding REITs fees and tax consequences
Understanding fees of investment is important because fees may significantly reduce your investments. Particularly, non-traded REITs usually have high issuer costs which include offerings fee, organizational cost, selling commission and fees. The costs can be up to, but not exceed 15% of the investment by regulations. For instance, if you decide to invest $20,000 in non-traded REITs with 15% front-end cost, then $3,000 (15% of the investment ) will be paid for investment costs and only $17,000 is left to work for your investment. Therefore, make sure that you know how much fees will be charged against your investment before making any investment decisions.
In addition, REIT shareholders are responsible for paying taxes on dividends and any capital gains on their REIT investments. Those dividend payout are treated as ordinary income, capital gains or return of capital. The maximum tax rate for capital gains on the sale of REIT stocks is 20%. You should consider their impact on your income taxes.
How to invest in REITs?
For publicly traded REITs, you can easily buy and sell them as stocks on the national security exchange. However, for non-traded REITs, you have to purchase them through brokers participating in non-traded REIT offerings. You also can purchase REIT mutual funds and REIT exchange-traded funds (ETFs).
How and how often are REIT dividends paid?
Investing in non-traded REITs may attract investors because dividends can be paid periodically to REITs shareholders. REIT’s board of directors by their fiduciary regulations decide the amount and time to pay out distributions. Many components are made in the distribution. If the company’s net cash of operation were less than their distribution, the distribution could have included the proceeds of selling new shares or borrowed funds. When the company increases its debt to pay distributions, it can eventually result in delaying or halting distributions.
Questions and Answers – REITs – what you need to know before investing
1. How are REITs different from other real estate companies?
Other real estate companies buy and develop real estate properties to resell them. However, REITs generally develop real estate properties and operate them as their own investment portfolio. REITs also sell their own long-term real estate properties.
2. What are Equity REITs?
Most REITs are equity REITs with a value of over 2.5 trillion in U.S real estate assets. Equity REITs own a portfolio of real estate properties such as office buildings, apartments, shopping malls and so on. They generate income through leasing those properties. Their income source is also from sales of properties.
Equity REITs are registered and regulated by the SEC. You can trade equity REITs as stocks, mutual funds, exchange-traded funds (ETFs). Equity REITs pay dividends to shareholders. Long-term equity REIT investors can also earn capital appreciation.
3. What are Mortgage REITs or mREITs?
Mortgage REITs typically invest in mortgages and mortgage securities of residential or commercial properties. Most mortgage REITs are registered with the SEC. They are traded on the national stock exchange. You can purchase these mortgage REIT shares in stocks, mutual funds, ETFs.
Some mortgage REITs are registered with the SEC, but not traded publicly on the stock exchange. They are referred to as non-traded REITs. Investors can purchase these non-traded REITs through brokers or financial advisors. Other mortgage REITs can also be private REITs.
4. What are the risks of investing in equity REITs?
Like other stocks, the price per share of equity REITs may be affected by inflation and the consumer price index (CPI). In addition, equity REITs own a collection of commercial real estate properties and commercial real estate properties have cyclical business. The cyclical business may have an impact on the REiT’s share price.
5. What are the risks of investing in mortgage REITs?
Mortgage REITs generate income from investing in mortgages and mortgage-backed securities. The volatility of interest rates, changes of borrowing terms, credit risk, overcollaterization, and payments collections can affect mortgage REIT’s operating margin as well as their mortgage assets.
6. How to minimize loss of mini tender offers?
You should be extremely cautious in dealing with mini tender offers that seek to purchase less than 5% of the company’s stocks. Those bidders do not refer to them as mini tender offers when they offer to buy your shares. You may lose control in tendering shares in mini tender offers. For instance, you may not be able to withdraw the offer even though the deal is not closed yet.
Therefore, you should have many questions and request answers about the deals before committing to any investments. Seek the help of your brokers or financial advisor if necessary.
Before selling your shares, you should figure out the market share price, ask for the disclosure and carefully review the disclosure before making any investment decisions; confirm the final price of shares and deductions, how and when the payments will be made; and understand the terms. You can always choose to sell your shares in different ways instead of via mini tender offers. For instance, after obtaining the share price valuation, you can sell your shares to your broker instead of offering your shares to mini tenders.
If you have any trouble with mini tenders, do not wait to act. You can seek the SEC’s help.
Source
Finra. Public non-traded REITs – perform a careful review before investing.
https://www.finra.org/investors/alerts/public-non-traded-reits-perform-careful-review-investing. Accessed July 12, 2021.
