Wednesday, May 21, 2014

Why I HATE Non-Publicly Traded REITs

As my experience in the financial planning and investment advisory industries has grown over the years, there is one investment that I've seen no logical reason to own -- non-publicly traded real estate investment trusts (REITs).

Josh Brown, one of my favorite analysts and author of nailed each of my frustrations with these products. Here is a significant excerpt from his post:

I consider non-traded REITs or nREITS to be part of the group of investments that are just absolute murderholes for clients – they pay the brokers so much that they cannot possibly work out (and they rarely do without all kinds of aggravation and additional costs).

Further, I have yet to hear a single credible explanation as to why a broker would recommend a non-traded REIT over a public REIT other than compensation. The only explanation that makes sense to me is that 7% is a lot more than the 1% commission you get doing an agency trade on a NYSE-traded REIT.

A reader with experience in the industry sent this to me and I found it hilarious. Below, a fictional, transparent conversation between an indie broker and his “client” that would never occur…

If Independent Brokers Were Transparent:


Before we wrap up our quarterly portfolio review I would like to talk to you about a new investment I think you might be interested in.  You have been looking for more income and this is an investment vehicle that pays a 7% dividend.


Sounds great, give me the details.


With your portfolio size and risk tolerance I would recommend a $100,000 investment.  Given that amount let’s first go over the fees. If you invest $100,000 I will be paid a commission of $7,000. My firm is going to get $1,500 – $2,000 in revenue share. My wholesaler, the salesman that works for the investment’s sponsor company, will get $1,000. He is a great guy, buys me dinner all of the time and takes me golfing. The sponsor company is going to get around $3,000 to pay for some of the costs they incurred in setting up the investment. So after Day 1 there will be around $87,000 left over to actually invest.  I bet you are getting excited.


Are you on drugs? Why would I pay 13% in fees on anything?


Don’t worry, it won’t feel like you are paying $13,000 in fees. The rules allow my firm to report your investment at $100,000 on your statement. You never really know what its worth but you will think you never lost money. Pretty sweet huh?


You have to be kidding.


No, this is a really good investment. Let me tell you about the income component before you jump to any conclusions. Like I said this investment pays a 7% dividend and the dividend won’t change.


That sounds high and how do you know it won’t change?


You see, the sponsor just picks the 7% dividend number out of thin air. Here’s how it works. You see the vehicle you are going to invest in is new and it’s going to take the firm a while before your net $87,000 is actually invested. Later on, maybe 2-4 years from now they will have the money fully invested and it will generate actual cash flow. So they just pay a quarterly dividend of 7% by giving you your money back.  This is great from a tax perspective because return of capital isn’t taxed as income.


Are we on hidden camera or something?


Ha, you are funny. I bet this next benefit will change your mind.


I hope so or I should start looking for another financial advisor.


This is the best feature. You can’t sell your investment until the sponsor has the opportunity to create liquidity. You might be locked up in this investment for 7-10 years.


This feels like the Twilight Zone. Your firm allows you to sell this crap?


Oh yeah, our firm sells a ton of it. In fact independent broker dealer firms like mine sold over $20 billion of these investments in 2013. Think about that. Reps like me made over $140 million dollars and our firms pocketed $20-$30 million.


This is crazy, what is this investment?


Non-traded REITs. $100,000 sound about right?

Josh touched on every part of these investments that I despise -- excessive commission paid to the so-called "financial advisor" (salesman), a supposed "dividend" that is really just paying the investor his own money back (essentially providing an interest-free loan), and a complete lack of liquidity and transparency.

When I begin working with a new client who owns one of these products, it is impossible to obtain accurate, current information on the investment (not even a true value is apparent). Even worse, if the client wants to sell the investment he would need to do so at pennies on the dollar. For the most part, once an investor purchases one of these products he just need to forget about it and hope that one day he can get his money back.

The bottom line is that if your advisor ever recommends a non-publicly traded REIT, I'd strongly recommend you walk out the door and start searching for a true financial advisor with a fiduciary responsibility to act in your best interest.

View Josh's post in full here.


Anonymous said...

Why don't you just not take the commission?

Lon Jefferies said...

I'd strongly recommend all consumers work with financial advisors who don't take commissions. They are called fee-only financial planners and a good place to start a search for one is

Additionally, the point remains that there is no reason to own this investment. If you are interested in real estate, invest in a publicly traded REIT that is fully liquid and transparent.

Thanks for the comment.

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