Non-Traded REITs: Risky, High-Fee Products

 A real estate investment trust (“REIT”) is an investment product that holds and often manages a portfolio of interests in income-producing real estate, such as commercial office space, apartment buildings, or hotels. REITs are structured to allow individual investors to acquire interests in real estate, and can be traded or non-traded.

Because REITs are complex investments, many investors rely on brokers to explain the risks and costs. Unfortunately, proper guidance is not always given.

Non-Traded REITs

Non-traded REITs, which are not listed on a public exchange, are generally marketed as safe investments that offer attractive dividends to investors looking for better-than-average returns. However, investors are not always fully informed of the risks and costs associated with non-traded REITs – which can be substantial. As a result, investor returns often fall short of expectations. As a commentator recently explained to the Wall Street Journal, “non-traded REITs are costing investors . . . billions. They're suffering illiquidity and ignorance, and earning much less than what they ought to be earning.1

In particular, sellers of non-traded REITs often do not fully explain the significant upfront fees and expenses that investors must cover – which can amount to 15% or more of a non-traded REIT’s share price. These costs can significantly reduce returns, especially when coupled with the ongoing expenses that non-traded REIT investors must cover. As studies have determined, these costs cause many non-traded REITs to considerably underperform relevant benchmarks.2

Despite these structural concerns, the non-traded REIT market has been rapidly growing. While sponsors raised $6.9 billion from investors in 2009, more than double that amount was raised in 2014 – and there are few signs that this growth will slow.

Heightened Scrutiny

In recent years, non-traded REITs have faced heightened scrutiny from federal and state regulators, who have investigated how non-traded REITs are structured and sold. Among other issues, high fees, a lack of transparency in pricing, and misleading marketing practices have all been the subject of government investigations. Prominent media outlets have additionally addressed high fees, risks, and misleading practices in the non-traded REIT industry.

Specific Risks Posed by Non-Traded REITs

Non-Traded REITs pose several significant risks. If you’re considering a non-traded REIT investment – or if you’ve already invested – consider the risks below.

Non-traded REITs require investors to pay upfront and ongoing fees that are higher than those associated with almost any other financial product – and these fees are not always fully explained. Upfront fees alone may comprise as much as 15% of an initial investment, and ongoing fees, commissions, and expenses further diminish returns. Indeed, a review of the SEC filings of 57 non-traded REITs in 2011 revealed that nearly 20 percent of every dollar invested in non-traded REITs is used to pay fees and commissions. Making matters worse, these fees are sometimes directed to affiliates of the entities involved in structuring and/or marketing non-traded REITs. Investor returns suffer.3

1Wall Street Journal, Nontraded REITs Are Hot, But Have Plenty of Critics, Robbie Whelan (June 15, 2014).
2 A Primer on Non-Traded REITs and other Alternative Real Estate Investments, Securities Litigation & Consulting Group 2012.
3 Even seemingly minor fees can have a significant adverse effect on an investor’s portfolio. As the United States Department of Labor has pointed out, in the 401(k) context a “1 percent difference in fees and expenses would reduce [a 401(k) participant’s] account balance at retirement by 28 percent.” U.S. Dept. of Labor Pension & Welfare Ben. Admin., A Look at 401(k) Plan Fees (updated August 2013).