Investors who want to be involved in real estate investing but don’t want the management of direct real estate can look at REITs (Real Estate Investment Trusts) as an option. REITs are securities that invest in real estate properties and offer a broad range of real estate exposure.
There are two primary paths for investing in REITs — public and private. Within the public domain are publicly-listed REITs and non-listed REITs. There are differences between these two, and which an investor chooses depends much on their investment suitability.
Profiling Investor Suitability Between Non-Listed And Publicly Listed REITs
If investing in real estate was the only concern for suitability, there wouldn’t be a way to choose between non-listed and publicly listed REITs. Both will give investors exposure to real estate.
However, many factors can help determine what is in the best interest of the investor between these two types of REITs. Some factors include risk tolerance, costs, liquidity, and current events.
Tolerance For Risk
Investors must consider the risk that something can go wrong with their REIT investment, wiping out all of their investment in the process. REIT investors are equity holders and sit at the bottom of the capital stack In the case of bankruptcy, equity holders generally don't receive anything. Investors should be comfortable with this risk and allocate capital appropriately.
We’re going to put volatility in this category as well. Publicly listed REITs have higher volatility than non-listed REITs. As the stock market moves up and down, sometimes in big swings, investors can expect their REITs to do the same.
Depending on how much of an investor's portfolio is allocated to publicly-listed REITs, their portfolio will be impacted by this volatility. Investors who have an aversion to such volatility should consider if publicly-listed REITs are the right choice.
Non-listed REITs usually have less volatility than publicly-listed REITs. Lack of liquidity is one reason behind the lower volatility. Investors in non-listed REITs often must hold the REIT for several years or face penalties and potential loss of principal for exiting early.
Some investors park money in non-listed REITs as a tax shelter. These investors may have entered the REIT through a 721 UPREIT exchange. By doing so, investors defer taxable gains. These tax shelter-seeking investors keep their money in the REIT for years at a time. This lack of transactions can reduce volatility.
Investors interested in tax sheltering through a 721 exchange or who desire lower volatility may find non-listed REITs attractive investments.
Costs
Publicly-listed REIT transaction costs are similar to that of a publicly-listed stock. In other words, costs consist of broker commissions for entering and exiting the REIT. These costs are fairly inexpensive.
On the other hand, non-listed REITs can have many different costs. These include up-front fees, transaction costs, and broker fees; some may charge management fees as a percentage of the investor's total investment. Additionally, there can be fees for existing the REIT early.
Liquidity
Publicly-listed REITs are very liquid. Investors generally do not have to be concerned with exiting their position for a large loss due to the bid/ask spread.
Non-listed REITs are a different story. These REITs do not trade often. Finding someone to buy your interest in the REIT can be very difficult. There are secondary markets for some non-listed REITs, but this doesn't mean there will be buyers for your interest.
Those investing in a non-listed REIT should be liquid. In other words, these investors don't have any concerns about needing their invested funds six months to a few years down the road.
Current Events
Office real estate is going through a transition with so many people working from home. Many larger non-listed REIT funds, such as those run by Starwood, Blackstone, and KKR, have made headlines lately by running into problems meeting redemptions. Needless to say, these headlines have not been positive.
Because property values in their funds have dropped, meeting redemptions can mean selling assets at significant losses. So these fund managers have limited redemptions.
For investors, such events can mean that you aren’t able to withdraw all or any of your money at a planned time. Of course, it can also mean a potential loss of principal.
Investors with limited finances probably aren't the best fit for non-listed REITs. For both categories of REITs we've discussed, investors with insufficiently diverse portfolios or those who have yet to give thought to their investment goals or risk tolerance are likely better off working with a financial advisor.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Risk tolerance is an investor’s general ability to withstand risk inherent in investing. There is no guarantee a recommended portfolio will accurately reflect your tolerance to risk.
All investments have an inherent level of risk. The value of your investment will fluctuate with the value of the underlying investments. You could receive back less than you initially invested and there is no guarantee that you will receive any income.
Hypothetical examples shown are for illustrative purposes only.
Investors who have sold real estate and executed a 1031 Exchange into a DST may execute future 1031 Exchanges and continue to defer taxable gains. Alternatively, a client may enter into a transaction pursuant to IRS Code Section 721 (also known as an UPREIT transaction). In an UPREIT transaction, Clients will receive, at the REIT Sponsor’s option, cash or OP units. OP units are units of an operating partnership that is wholly owned by a REIT. If the client receives OP units, he or she has exchanged into a security and therefore no longer owns real estate and cannot execute another 1031 Exchange out of the OP units and into other real estate. However, pursuant to IRS Code Section 721, the UPREIT transaction into the OP units may qualify as a tax-deferred exchange. The disposition of their interest in OP units will result in a taxable transaction, including the recognition of their deferred capital gain and any depreciation recapture. The client’s gain will only be recognized upon sale or disposition of the OP units. There is no guarantee that an UPREIT transaction will occur. The option for this transaction is at the discretion of the REIT Sponsor. Some DSTs allow the client to choose whether to take OP Units or cash. Clients should consult the prospectus and their advisor regarding the specifics.
Holdings will generally be illiquid until which time they are converted to OP units. Even after exchanging into the OP units, repurchase of the OP units by the REIT Sponsor is at their discretion via their share repurchase plan which may be modified, suspended or terminated by the board of directors of the REIT at any time.
There are risks associated with REITs and may include but are not limited to the following:
- They may be illiquid with no secondary market.
- Potential difficulty discerning between routine interest payments and principal repayment.
- Redemption price of a REIT may be worth more or less than the original price paid.
- Value of the shares in the trust will fluctuate with the portfolio of underlying real estate.
- There is no guarantee you will receive any income.
- Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes.
This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus.
