The Financial Industry Regulatory Authority (Finra) today issued an alert ton public non-traded REITs, warning investors that they should be wary of distribution, liquidity and valuation issues when partaking in these investments.
Finra officials also warned that early redemption of such shares is frequently limited, and fees connected with their sale can be high and erode total return.
"Confronted with a volatile stock market and an extended period of low interest rates, many investors are looking for products that offer higher returns in turbulent times," said Gerri Walsh, Finra vice president for investor education.
Walsh also advised investors to be wary of sales pitches that may play up non-traded REITs' high yields and stability, but downplay their lack of liquidity, fees and other risks.
REITs pool the capital of numerous investors to purchase a portfolio of properties-from office buildings to hotels and apartments, even timber-producing land-which the typical investor might not otherwise be able to purchase individually.
Finra listed a number of public non-traded REIT characteristics that investors should be aware of:
Distributions are not guaranteed and may exceed operating cash flow. In newer programs, distributions may be funded in part or entirely by cash from investor capital or borrowings. Distributions can also be suspended for a period of time or halted altogether.
Lack of a public trading market creates illiquidity and valuation complexities. 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. Many factors affect the valuation of non-traded REITs, including the portfolio of real estate assets owned, strength of the trust's balance sheet, overhead expenses and cost of capital.
Early redemption is often restrictive and may be expensive. Most non-traded REITs place limits on the amount of shares that can be redeemed prior to liquidation. These limits can be as restrictive as 5% or even 3% of the weighted average number of shares outstanding during the previous year. Additionally, the redemption price is generally lower than the purchase price, sometimes by as much as 10%.
Non-traded REITs can be expensive. State and FINRA guidelines limit front-end fees to 15%, but a 15% front-end fee on a $10,000 investment means that only $8,500 is going to work for an investor.
Finra also warned investors about private REITs-generally sold only to accredited investors-which do not trade on an exchange and are generally exempt from regulation. FINRA officials caution that it is extremely difficult for investors to make an informed decision about private REITs due to their lack of disclosure documents.