A REIT (Real Estate Investment Trust) is a tax-advantaged investment vehicle created in 1960 as part of the Cigar Excise Tax Extension with the purpose of buying and holding real estate. They are able to generate risk adjusted returns primarily through rental income, but also through the appreciation of held real estate assets.
REITs are required to return 90 percent of earnings to investors in the form of dividends. To qualify as a REIT, the controlling entity must be managed by a board of directors or trustees, have at least 100 shareholders after its first year, have no more than 50 percent of its shares owned by five or fewer individuals, and must derive at least 75 percent of its gross income from real estate related sources.
REITs are not taxed on most of their earnings, as the taxes are paid by investors when they claim dividends as income. However, because 90 percent of income goes straight to investors, REITs often have lower growth rates than other investment vehicles, as they are only allowed 10 percent of their earnings to reinvest in growth.
While some REITs are traded on public exchanges like NYSE and NASDAQ, non-traded REITs are sold by individual brokers. By remaining off of exchanges, non-traded REITs experience lower volatility and are less correlated to the stock market. Because of this, the value of a non-traded REIT is dictated by the valuation of its assets rather than by market sentiment, giving investors a better idea of the true material value of the investment. This also means that managers are able to focus on long-term investment goals without the risk of upsetting investors who may watch for daily price changes in the market.
Unlike many non-listed investments, non-traded REITs are available to the public, with no accreditation limitations. As such, they are still subject to the same SEC reporting and regulations as those listed on exchanges, and should not be confused with fully private REITs, which are exempt from registration with the SEC.
The trade-off comes in liquidity risk. Because of the lack of a secondary market, shares of non-traded REITs are significantly more difficult to sell. Non-traded REITs usually have a five to seven year hold period, whereas publicly listed REITs can more-or-less be bought and sold at will. While some non-traded REITs have limited redemption programs, many still require a minimum hold period before those programs become available. And, because they are sold by broker-dealers instead of traded on exchanges, non-traded REITs may come with high upfront fees.
Non-traded REITs can give retail investors access to real estate that would otherwise be inaccessible. They have the potential to generate income for investors through the distribution of earnings gained through rent payments. REITs with assets that have fully occupied properties, long-term leases, and reliable tenants may be positioned to generate income through recurring dividend distributions. Long-term investors in REITs with regular payouts can re-invest their dividends, which can potentially help further grow the trust and generate attractive risk-adjusted returns.
As with any real estate investment, there are a number of other risk factors that should be considered, such as declines in market value, local economic conditions, operating costs, natural disasters, and more.
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