What is a REIT?
If you haven’t heard of REITs, they are companies that manage portfolios of direct real estate for you. For that convenience, they charge a fee. Instead of having to learn about real estate (like you’re doing right now), a professional manager does it for you.
In addition, one type of REIT (publicly listed REIT) trades on public exchanges. This means you can move your money in and out at any time. In the previous article we discussed one of the main disadvantages of direct real estate is its lack of liquidity. Publicly listed REITs don’t have this limitation, which is a strong advantage if you have an emergency and need the funds quickly.
So on the surface, it seems like a REIT is the perfect way to invest in real estate. However, if you look deeper, you’ll see many limitations, that make REITs unsuitable as a core real estate investment vehicle, for most investors.
What can go wrong with a REIT?
There are three different types of REITs, and each has its own unique limitations when compared to direct real estate investment.
Investing in private REITs is like dating your dream celebrity of choice. On paper, it’s everything you could possibly want. In reality, they’re unlikely to let you do it.
Nonlisted REITs have exorbitant fees, a track record of extremely poor performance, and FINRA warnings about Ponzi schemes resulting in “zombie REITs”.
Publicly listed REITs may have a place in your real estate portfolio. But due to key limitations, they are rarely an ideal core investment.
Here’s the details…
Private REITs: The celebrity you’ll never date.
Private REITs are nonpublic, and are not traded on the stock exchange.
Many novice investors and inexperienced advisors confuse them with nonlisted REITs (which are completely different, and we’ll talk about next).
The top private REITs have billions/trillions of dollars in assets. Due to their massive economies of scale, their management fees are amazingly low (for an investment requiring such active management): often around 1%. They have no load fees nor broker fees. And the top private REITs don’t just try to match their benchmark index (NPI or NFI-ODCE). They make up the index.
With their perfect trifecta of low fees, economies of scale and world-class managers, investing in a private REIT is the real estate equivalent of dating your favorite celebrity.
Unfortunately, just like your favorite celebrity, your odds of being accepted by them are extremely slim. Most won’t accept money from individuals, and deal exclusively with billion-dollar institutions and pension funds. The few that will, require minimum investments of $5 million.
This makes them a non-option for most investors
Nonlisted REITs: Broker’s dream/investor’s nightmare
Nonlisted REITs (also called nontraded REITs) are also nonpublic, and also not traded on the stock exchange. Unlike private REITs, they are known for exorbitant fees (annual fees, load fees, broker fees), and poor returns.
Front end fees can be as painfully high as 15%. Brokers take an additional pound of flesh as high as 10%. And yearly management fees are often exorbitant as well.
Since they pay such high commissions, brokers recommended over $20 billion of these to unsuspecting clients, between 2009 and 2013 alone. Many nonlisted REITs lured in investors with rates higher than they could afford to pay. Ultimately, many investors lost money. And worse, as the Wall Street Journal described in 2015 in their article “Property Investors’ Latest Horror: Zombie REITs”: a significant number still haven’t gotten their money back, and don’t know if and when they ever will.
So many nonlisted REITs have gone zombie, that FINRA (the Financial Industry Regulatory Authority) issued a warning about them:
“Furthermore, the periodic distributions that help make these products so appealing can, in some cases, be heavily subsidized by borrowed funds and include a return of investor principal”
This is exactly how Bernie Madoff operated his Ponzi scheme.
Nonlisted REITs are excellent moneymakers for your broker and the fund itself. In my opinion, they are a completely unsuitable investment for any investor that has any other options.
Publicly listed REITs
Publicly listed REITs trade on the stock exchange. As a result, you can cash in and cash out of your investment at any time. This is a significant advantage over the other types of REITs, and direct real estate investment. All of these require you to lock up your money for some period of time.
But this liquidity comes at a cost: volatility, loss of diversification protection and liquidity premium. As a result, public REITs can be useful, but usually not as a core investment.