"We sell our products as a way to own hard assets that provide stable cash flow," he says. "We don't sell them as liquid investments. They're not meant to be trading vehicles, unlike publicly traded REITs."
Shafer provides a checklist of things to consider before investing in private REITs: the financial strength of the offerings; the funds-from-operations payout rate (FFO measures a REIT's ability to generate cash); debt levels and maturities; and the investment thesis of the REIT and when it acquired its properties.
But redemption demands have recently increased in non-traded REITs, raising fresh concerns about their inherent liquidity problems. "Most of the major sponsors have suspended their share repurchasing programs because redemptions overwhelmed them," says Gannon from Robert A. Stanger.
Cole Real Estate Investments hasn't suspended redemptions yet, but it could. "Cole and a lot of non-traded REITs typically retain the right to either terminate or adjust their redemption schedule," says Towle. Cole operates three non-traded funds-including one that's currently raising cash-focused on big-box retail centers anchored by the likes of Wal-Mart and Home Depot.
In Cole's case, redemptions aren't allowed in the first year, and in the second year the redemption rate is 95% of the $10 per share purchase price. That rises to 97.5% in the third year, followed by 100% after that. Even then, Cole puts a cap on the number of shares that can be redeemed in one year to an amount not exceeding 5% of the weighted average number of shares outstanding in the 12 months before the redemption date. Most other non-traded REITs have similar restrictions.
New Product
People think of non-traded REITs as something sold rather than bought. "It wouldn't be unfair to say that the average person doesn't wake up in the morning and says, 'Buy me a non-traded REIT,'" Gannon says.
Still, sponsors of non-traded REITs have raised $60 billion in equity since 2000, according to Commercial Real Estate Direct, an online news service. For now, they're sold in the advisor channel, mainly through broker-dealers, although Gannon says they are starting to penetrate the fee-based market in wrap-type accounts where advisors waive the up-front commission and get their fee from the account itself.
Gannon says a new non-traded REIT from Merrill Lynch might accelerate that trend. The product, NorthEnd Income Property Trust, was filed with the SEC in January and will employ BlackRock Realty Advisors as a subadvisor. According to its regulatory filing, the fund hopes to raise up to $2.25 billion to invest in a mix of commercial properties across the U.S. and Canada.
The minimum investment will be $1,000, and the share price will be set at $10.25. After the escrow period, the share price will vary daily based on the net asset value divided by the number of shares outstanding. The front-end commission will be 2.5%, and advisors will get 35 basis points per year from the account until they earn a total fee of 10.5%. In addition, the fund will allow for daily redemptions on any portion of their shares.
"If this catches on, I think more guys will do this," says Gannon, referring to non-traded REIT product sponsors such as Wells Real Estate Funds, Behringer Harvard, Grubb & Ellis Realty Investors and the like. He also thinks it could entice other financial services companies to join the fray, such as UBS and JPMorgan Chase & Co.