Publicly traded REITs and non-exchange-traded net asset value (“NAV”) REITs have enjoyed a strong run the past few years as investors have scoured the investment landscape for income. But different factors are driving these investment vehicles, and it’s important to look under the hood before parking clients in either, say REIT experts.

Traded REITs are valued daily and offer daily liquidity. NAV REITs, perpetual-life products, are valued daily or monthly and offer periodic limited liquidity. NAV REITs were initially introduced before the Great Recession, but the Blackstone Real Estate Income Trust (BREIT), rolled out in 2017, was the first to get significant traction.

Other institutional managers have followed Blackstone’s lead with their own NAV REIT offerings. NAV REITs have stolen the thunder from traditional non-traded REITs (often referred to as life cycle REITs), which have a limited life and were plagued by a raft of problems associated with some sponsors, most notably Realty Capital’s Nicholas Schorsch.

When selecting a REIT structure, advisors should consider a client’s penchant for liquidity and stability, says Kevin Gannon, chairman and CEO of Robert A. Stanger & Co., a real estate investment banking firm based in Shrewsbury, N.J.

Traded REITs carry a bit more volatility than NAV REITs, he says, because the markets can be rattled by many macro-related reasons that aren’t necessarily related to real estate. The coronavirus is a recent example, he says. The impact of rising interest rates can often be felt more immediately on traded REITs than on non-traded REITs, he adds.

In contrast, a NAV REIT “mirrors the performance of the underlying real estate, without the mood swings of the financial markets,” says Gannon. “It’s generally not going to swing wildly absent some correction in real estate prices.”

Generally favorable demographic trends, a growing economy, job growth and low unemployment have been positives for all kinds of real estate lately, he says, and NAV REITs have a multi-class focus.

Traded REITs far outperformed NAV REITs last year, but Gannon says it was more about recovering some of the price depreciation they faced in 2017 and 2018 than about real estate performance. “They kind of got back on track,” he says.

While traded REIT indexes zigzagged, the Stanger NAV REIT Total Return Index has climbed steadily since 2017. Its cumulative three-year total return as of December 31, 2019, was 24.38%. The three-year total return was 14.17% for the Stanger Lifecycle REIT Total Return Index.

NAV REITs, which now account for more than 95% of the money raised for non-traded REITs, have resonated the past couple years with investors seeking more frequent valuation information and greater liquidity than what life cycle REITs offer, says Gannon.

That said, he doesn’t expect life cycle REITs to disappear because they give investors the opportunity to invest in the markets they anticipate will have the most upside over the next five-to-seven-year real estate cycle without having to think in perpetuity.

One Size Fits All
Unlike many private investments, NAV REITs aren’t restricted to accredited investors.

“A mom and pop retail investor, for $30,000 or $50,000, can get the same exposure to an institutional real estate manager as the major pension funds in this country,” says Gannon, who sees this as a game changer.

Also changing the industry dynamic, he says, is the entrance of major institutional asset managers into the NAV REIT market. Joining Blackstone are Nuveen, Griffin Capital, Starwood Capital, Oaktree and Clarion, to name a few.

The asset managers are using all their financial techniques (including leverage) and their acumen in acquiring real estate, he says. They have the financial muscle to renovate properties they purchase, and they know how to “scrub the pennies off,” he says, to get more net operating income out of them. In addition, he says, “These big, credible players are paving the way for others entering the market.”

Stanger projects non-traded NAV REITs will raise more than $15 billion in 2020, up from more than $11.8 billion in 2019. Gannon anticipates more traditional non-traded REITs will be converted into NAV REITs, despite the expense and challenge, because asset managers generally want to hold onto assets under management instead of liquidating them. The assets in a traditional non-traded REIT are often liquidated to give investors back their money at the end of the REIT’s life cycle.

To compare the yields on NAV REITs and traded REITs, Gannon suggests looking at the returns on NAV REIT “I” shares, which don’t have loads or commissions. “On a current basis, in the NAV REITs it’s usually something in the 5’s,” he says, “versus the traded REITs, which are probably in the 4’s or less.”

Sometimes the income is lower, however. The Vanguard Real Estate Index Fund ETF was yielding 3.35% in early February.

Jordan Heller, a managing director with Beacon Pointe Wealth Advisors and the partner in charge of the RIA firm’s New York tristate area operations, is using private REITs and niche private real estate funds for clients. These niches include senior housing, affordable housing and critical infrastructure investments.

“We appreciate the income stream as well as the more stable valuations relative to the public equity markets,” he says. “We do not mind locking up funds, provided we are getting compensated for the illiquidity.”

Heller, who brought many REITs public between 1987 and 2000 while working on Wall Street, is less actively using publicly traded REITs given their current valuation levels.  “Should there be a decline in the public REIT market,” he says, “we would feel comfortable stepping in knowing that the net asset value of the underlying entities would be terrific support in limiting our downside while collecting a compelling dividend.”

Building A Better Mousetrap
NAV REITs are “an exciting corner of the market,” says Ettore Santucci, co-chair of the REITs and Real Estate M&A group at law firm Goodwin Procter LLP and one of the Goodwin partners who developed the NAV REIT structure circa 2003. Still, he sees room for improvement in these products—particularly with regard to liquidity.

NAV REITs are more liquid than traditional non-traded REITs, but their aggregate redemptions by shareholders are typically limited to 5% of net asset value per calendar quarter or 20% per year.

“When people get stressed, they clamor for a limited amount of liquidity,” says Santucci. NAV REIT provisions about gating or queuing redemptions may not be enough to control outflows. David Roberts, a partner and member of the REITs practice at Goodwin Procter, also points out that NAV REIT investors who don’t need immediate access to liquidity are still paying for it through lower dividend yields. “Everybody is in the same boat,” says Roberts.

Santucci, Roberts and their colleagues are proposing to their clients a split-class arrangement for NAV REITs that would provide higher dividend yields for less liquid share classes and lower dividend yields for more liquid share classes. They think this arrangement (which they say is not currently available with NAV REIT offerings) could control a bit of the redemption risk and reduce the need for NAV REITs to sell off assets.

“The split class is effectively nothing other than a way to build a toll highway and a freeway,” says Santucci, who notes that financial advisors could match clients’ duration and risk profiles to the subclass best suited to the clients’ needs.

Advisors should disclose redemption features to clients, says Gannon, but so far redemptions haven’t been a big issue with most of the REITs. Still, “You shouldn’t be jumping in and out of real estate,” he says. “If you have a horizon in your mind of seven to 10 years, real estate is a good place to invest money.”