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Real Estate Investment Trusts 

These popular investment vehicles are designed to generate regular income streams and grant investors access to diversified portfolios of properties.

REITs, or real estate investment trusts, are companies that own, operate, or finance income-producing properties.

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Understanding REITs

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Real Estate Investment Trusts (REITs) are popular investment vehicles due to their potential for diversification, ability to generate income, and provide investors access to institutional-grade real estate investments. But not all REITs are the same. There are three main types of REITs, each of which must be evaluated to ensure they are a worthwhile investment that fits within an investor’s desired investment strategy.

The following information breaks down the differences between types of REITs, reviews important trends, and highlights what financial professionals need to know before recommending REITs to clients.

Classification of REITs

What is a REIT?

A REIT is a tax-advantaged investment vehicle created in 1960 as part of the Cigar Excise Tax Extension with the purpose of buying and holding real estate. They are able to generate risk-adjusted returns primarily through rental income, but also through the appreciation of held real estate assets.

REITs are required to return 90 percent of earnings to investors in the form of dividends. To qualify as a REIT, the controlling entity must be managed by a board of directors or trustees, have at least 100 shareholders after its first year, have no more than 50 percent of its shares owned by five or fewer individuals, and must derive at least 75 percent of its gross income from real estate-related sources.

REITs are not taxed on most of their earnings, as the taxes are paid by investors when they claim dividends as income. However, because 90 percent of income goes straight to investors, REITs often have lower growth rates than other investment vehicles, as they are only allowed 10 percent of their earnings to reinvest in growth.

Non-Traded REITs

While some REITs are traded on public exchanges like NYSE and NASDAQ, non-traded REITs are sold by brokers and advisors. By remaining off exchanges, non-traded REITs experience lower volatility and are less correlated to the stock market. Because of this, the value of a non-traded REIT is dictated by the valuation of its assets rather than by market sentiment, giving investors a better idea of the true material value of the investment. This also means that managers are able to focus on long-term investment goals without the risk of upsetting investors who may watch for daily price changes in the market.

Unlike many non-listed investments, non-traded REITs are available to the public, with no accreditation limitations. As such, they are still subject to the same SEC reporting and regulations as those listed on exchanges, and should not be confused with fully private REITs, which are exempt from registration with the SEC.

The trade-off comes in liquidity risk. Because of the lack of a secondary market, shares of non-traded REITs are significantly more difficult to sell. Non-traded REITs usually have a five-to-seven-year hold period, whereas publicly listed REITs can more or less be bought and sold at will. While some non-traded REITs have limited redemption programs, many still require a minimum hold period before those programs become available.

Non-traded REITs can give retail investors access to real estate that would otherwise be inaccessible. They have the potential to generate income for investors through the distribution of earnings gained through rent payments. REITs with assets that have fully occupied properties, long-term leases, and reliable tenants may be positioned to generate income through recurring dividend distributions. Long-term investors in REITs with regular payouts can re-invest their dividends, which can potentially help further grow the trust and generate attractive risk-adjusted returns.

Publicly Traded REITs

Investing in a publicly traded REIT is done via a similar process to investing in other exchange-traded public securities. Shares can be bought and sold on exchanges like NYSE and NASDAQ, making them highly liquid with standard trading fees. Additionally, there is no accreditation requirement which means anyone can invest.

Because these REITs are listed on the public market, valuation is determined by the market and changes daily. This also means that publicly traded REITs are highly correlated with the stock market and are subject to market volatility. As a result, managers of traded REITs may have more of a focus on producing short term earnings rather than long-term growth. The trust must be registered with and is regulated by the SEC. This means they are required to make regular disclosures, including quarterly and annual audited financial reports.

Private REITs

Unlike those that are publicly traded and non-traded, private REITs are not required to register with the SEC and are not subject to the same reporting requirements. While they are not regulated by the SEC, private REITs are required to conform to Regulation D. Private REITs are only available to accredited investors, have high investment minimums, and are highly illiquid. Much like non-traded REITs, private REITs are often sold by broker-dealers and may feature high fees. They are not correlated with the stock market, and are valued based on an appraisal of assets. There is usually little-to-no information about private REITs that is made available to the general public, including management strategy, performance, and fee structure, all of which vary from investment to investment.

Advisors need to consider their investors’ goals and risk tolerance when deciding if they want to allocate to REITs. As with any investment, there is no guarantee of success, and there are real estate-specific risks associated with REITs. While REITs often make regular distributions, in order to maintain the regularity of distributions REIT managers sometimes subsidize those distributions with debt or even investor principal. Additionally, advisors will want to remind investors that distributions are usually taxed as normal income, rather than capital gains, which may mean a different tax rate applies than usually expected from their investments.

While non-traded and private REITs have a reputation for their ability to produce attractive risk-adjusted returns, advisors need to strongly consider the risks associated with illiquid real estate investments and weigh them against the risks of market correlation and daily price fluctuations that come with publicly traded REITs.

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Considerations for Financial Professionals

The State of the REIT: Fundraising, Fees, and Innovation

The non-traded REIT market has ebbed and flowed over time due to market fluctuations and combined factors such as regulatory changes, product innovation, and stronger alignment of interests between sponsors, advisors, and investors.

According to data from investment banking firm, Robert A. Stanger & Co., non-traded REITs raised $33.2 billion in 2022, down slightly from 2021’s market peak of $36.5 billion raised. Last year saw a significant slowdown, coming in just shy of $10 billion for 2023, due to rising interest rates.

Rising embrace of non-traded REITs has come despite the sector’s struggle to move away from high up-front fees, which seek to cover selling commission and other costs associated with the funds’ formation. Throughout the lifecycle of a non-traded REIT, property acquisition fees and asset management fees can stack up. Fees of 10 to 15 percent of the gross investment amount are common. In reality, this means that only 85 to 90 percent of an investor’s commitment is put to work. However, investor statements still report the REIT value at par before fees. This is referred to as the REIT’s Net Investment Amount (NIA), rather than the Net Asset Value (NAV).

General securities members are required to provide accurate per share estimated values on customer account statements, shorten the period before a valuation is determined based on an appraisal, and provide various important disclosures. This transparency surrounding the underlying value of the real estate held in a customer’s account has helped shed light on fee drag.

Ebbs and flows aside, the reasons for including REITs in a well-diversified, thoughtful portfolio never went away. The income-driven, inflation sensitive, semi-uncorrelated nature of the asset class continues to make a strong argument for inclusion in sophisticated portfolios. Sponsors like Blackstone, Griffin, and Cantor Fitzgerald have engineered REIT products that embrace the move toward greater transparency around value, fees, and performance. By eliminating acquisition, disposition, financing and/or development fees from the overall fee structure and by reporting the NAV instead of the NIA, sponsors have better aligned interests between sponsors, advisors, and their investors.

Sponsors continue to be paid management fees and a performance incentive over an annual return hurdle while investors benefit from more frequent reporting, increased competition between product sponsors, and a greater portion of their investment “in the ground.” Attractive share repurchase plans are an added benefit, offering the potential for improved liquidity to shareholders over the non-traded REIT products of the past and strengthening the case for higher portfolio allocation.

More sponsors are following suit and creating non-traded NAV REITs with multiple share classes that make the asset class more accessible through a variety of channels. Broker-dealers and RIAs can offer the same product via different share classes with a transparent selling commission made available to selling brokers. Some sponsors are selling directly through RIAs and can attract retail investors directly.

According to data from investment banking firm, Robert A. Stanger & Co., non-traded REITs raised $33.2 billion in 2022, down slightly from 2021’s market peak of $36.5 billion raised.

Technology Solutions Create Efficiencies

Sponsors and advisors are embracing new fee structures of non-traded REITs but are also incorporating technology solutions to streamline costly back-office operations. In 2017, the North American Securities Administrators Association (NASAA) developed guidance on the use of electronic signatures for non-traded REITs. This has paved the way for straight-through processing technology, which allows advisors and sponsors to save time and money by creating efficiencies in a traditionally error-prone and paper-laden investment process.

While they provide a compelling set of benefits, it should be noted that, like any investment, non-traded REITs come with risks, including illiquidity, loss of principal, real estate risks, and more.

*SEI is not affiliated and does not endorse the sponsors mentioned in this article.The information contained herein is for general and educational information purposes only and is not intended to constitute legal, tax, accounting, securities, research or investment advice regarding the strategies or any security in particular, nor an opinion regarding the appropriateness of any investment. This information should not be construed as a recommendation to purchase or sell a security.

Free Download

Understanding REITS

Learn more about this popular tax-advantaged investment vehicle.

Get My E-Guide