Non-traded real estate investment trusts (REITs) continue to be a popular investment in the current market, but many people don't understand how they really work. The potential for financial harm can be high if you put your money into an unsuitable non-traded REIT and don't take into account how well it works in your overall financial picture.
An REIT is a real estate investment through a corporate entity. Corporate taxes are avoided with a REIT, but 90% of the income must be distributed. They come in two main types:
The first is traded on an exchange, and the share price changes according to market fluctuations. The latter, on the other hand, does not trade on a public exchange. A broker can show the purchase price of the REIT (typically $10 per share) for a long time before establishing a market value. Although the broker only has 18 months after the offering period ends to establish the market price, the offering period is often as long as 3 years or more. This means the purchase price could be reported for as long as 4 or 5 years before a market price is established. During that time period, investors may have a tough time figuring out what the real value of the REIT is.
Additionally, the amount actually invested in the REIT could be as much as 15% less than you put up. Some of the cash goes into commissions to the broker, and some will go into various up-front fees. Even though these amounts are subtracted, the brokerage statement will still show the value of the REIT as through those fees and commissions were not subtracted.
For example, a $10 REIT that sold 10,000 shares would be reported to be worth 100,000—even though the actual amount invested could be more than $10,000 less! The Financial Industry Regulatory Authority (FINRA) would like to see this practice ended, and has proposed a new rule requiring that non-traded REITs show this deduction. In the meantime, investors should be aware of these complex investments and ask their brokers about any fees or commissions involved.
As you can see, REIT investments get complex fast, and they may not be suitable investments for every investor. Be sure to always carefully research REITs and understand what you're putting your money into and how you'll be paid.