xtended periods of uncertainty in the stock market along with low interest rates can drive investors seeking higher returns into the arms of products that they may not fully understand or that may not be appropriate for their financial situation or risk tolerance. Take non-exchange traded real estate investment trusts (REITs), usually referred to as "non-traded REITs." A particularly egregious case we're currently handling reminded us that we needed to get the word out once again about the danger of buying into non-traded REITs if you don't fully grasp how they work. Of course, it's not the customer who would generally consider purchasing such sophisticated financial products; rather, brokers are pitched on such products by REIT representatives; and, seduced by promises of low-risk and high-return, the brokers in turn pitch their clients on them.
(Very quickly, if you're not familiar with the concept of a "REIT:" a REIT is a trust or company that pools individual investments to purchase large portfolios of income-producing real estate. A very large percentage of the income from these properties is then disbursed annually to shareholders in the form of their distribution or return.)
Before you agree to the purchase of a non-traded REIT at your broker's suggestion (if it's not too late already), bear in mind three very important things:
- hares of non-traded REITs by definition do not trade on any national securities exchange
- arly redemptions of the shares you own in a non-traded REIT are strictly limited and in any case come with high fees that cut deep into your potential return
- Unlike in publicly traded companies, the distributions or returns ou get from non-traded REITs often come from borrowed funds or investor principal
1) The first item means that it can very difficult to determine the value of your investment in the REIT, especially if it starts to go bad. Since the REIT is not part of any actual market or exchange, its valuation is assigned internally and can often be inaccurate or manipulated by those running the fund. Moreover, until the shares are actually sold, the valuation of those shares is pure speculation. It's like a company going public for the first time: the value of its shares can fluctuate wildly in the initial offering and more often than not fails to correspond to projections, even by the experts.
2) Non-traded REITs are an illiquid investment. Be prepared to have your money locked up in a REIT for at least 8 years, possibly longer. In the meantime, if your financial situation changes, and you need to get out of the REIT, you face steep fees and losses.
3) A unique feature of non-traded REITs is that he distributions or returns you get from them do not come out of earnings or profit, but rather from heavily subsidized debt or initial investor principal. When things go bad, and a non-traded REIT starts losing money, this can look a lot like a Ponzi scheme in that new investors are paid distributions from early investor principal. In some cases, a failing REIT will suspend distributions entirely, n which case not only will an investor be stuck in an illiquid product but it's an illiquid product that provides them with no return whatsoever.
In investing, as in much else, knowledge is power. Know what you're getting into if you agree to purchase shares in a non-traded REIT. And if you don't know what you're getting into, ask your broker to explain everything to you--along with why he or she thinks this financial product is good for you. For more on non-traded REITS, consult FINRA's tip sheet here.
f you or anyone you know has been the victim of broker misconduct related to the purchase of non-traded REITs or any other financial product, please contact us for a free consultation.