Portfolio Strategy - February 27, 2023

Non Traded REITs, Private REITs, and the Quest for Diversification

February 27, 2023

Soren Godbersen
By Soren Godbersen

In the vast realm of real estate investment, REITs (real estate investment trusts) offer distinct benefits to individual investors. However, there are a number of different structures of REIT which all behave a bit differently: public (traded REITs), non traded REITs, and private REITs. 

This article dives deep into the nuances of different types of REITs illuminating their structure, advantages, potential drawbacks, and their appeal to the accredited investor. EquityMultiple provides private-market real estate investments. While the majority of our investments are single-asset, we have also provided non traded REITs and private REITs at a low barrier to entry. Both structures may offer advantages to individual accredited investors as part of a diversified real estate portfolio. 

What Are the Different Types of REITs?

Let’s take a moment to recap what non traded REITs are, as well as other types of REITs (real estate investment trusts):

Public Non Traded REITs

Public non-traded REITs (otherwise known as “public non-listed REITs” or PNLRs) are generally open to non-accredited investors and often have minimum investment requirements that place them between most private REITs and publicly traded REITs. Rather than trading on public exchanges, investors purchase shares of non-traded REITs directly from a broker-dealer. Typically, this product’s total return is a combination of dividends and appreciation of Net Asset Value (NAV). NAV is calculated as the total value of the entity’s assets minus the value of its liabilities. 

A public non-traded REIT is generally illiquid, but certain securities may be sold after an initial hold period – for example, after one year, within certain intervals (monthly or quarterly), and potentially at a discount to NAV if redeemed early. Non-traded REITs are also highly regulated at state and federal levels – including by FINRA and the SEC – and are required to file all material company disclosures such as quarterly and annual reports, 8Ks, and proxies.

Private REITs

As the name implies, information regarding Private REITs is rarely made public. They are neither registered with, nor regulated by, the Securities Exchange Commission (SEC) and bear limited reporting requirements. The minimum investment amount is traditionally highest when compared to other REIT options, potentially as much as $100k or more and, as such, are generally only accessible to high net-worth individuals. Private REITs are very illiquid and difficult to redeem.

Note: EquityMultiple’s Ascent Income Fund is structured as a private REIT, but with a minimum investment of just $5K for first-time EquityMultiple investors, and does offer redemption options.

Publicly Traded REITs

A publicly traded REIT is so-called because it is listed on a public stock exchange, such as the New York Stock Exchange or NASDAQ. The minimum investment for a publicly traded REIT varies greatly, however they typically have the lowest entry point for investors. Traded REITs are highly liquid with the largest REITs experiencing hundreds of thousands of trades every market day. In addition to liquidity, publicly traded REITs are also open to investors of all types. Publicly traded REITs are registered with and regulated by the SEC and are required to file ongoing notices that are deemed material to the company. 

Note also that publicly traded REITs may be further aggregated into real estate mutual funds or ETFs (such as the Vanguard Real Estate ETF)

Taxes and REITs

Documentation

As a REIT investor, you will receive a 1099-DIV form. The 1099-DIV will include details on all dividends you earned throughout a tax year. REIT dividends may be categorized as ordinary dividends, qualified dividends, or a return of capital, which are all taxed at different rates.

  • Ordinary (non-qualified) dividends are taxed at the ordinary income tax rates according to your income tax bracket.
  • Qualified dividends are taxed at long-term capital gains rates. These dividends must be paid by a U.S. company, a qualified foreign corporation, or by a company traded on an American exchange. Investors receiving qualified dividends must own the stock for more than 60 days in the 121-day period beginning 60 days before the ex-dividend date.
  • Return of capital is a payment a company makes to its investors that is drawn from its paid-in-capital or shareholders’ equity.

In any given tax year, an investor can receive each class of these dividends. Note that EquityMultiple does not provide tax advice. Please consult a licensed professional for any tax questions regarding real estate investing.

REIT Tax Treatment

The 2017 Tax Cut and Jobs Act (TCJA) allowed for more favorable tax treatment for REIT investors. Thanks to TCJA, REITs, when held in taxable accounts, are virtually equated to regular qualified dividend-paying companies. Investors are now able to deduct up to 20% of ordinary REIT dividends, generating a small reduction in tax rates, while also leading to an after-tax savings of 25%. The tax cut effectively decreased the top marginal rate on ordinary REIT dividends from 39.5% to 29.6%. Before TCJA, many advisors encouraged their clients to invest in REITs via tax-advantaged accounts. Now investors are able to enjoy similar tax treatment using both tax-advantaged and taxable accounts.

Understanding Non Traded REITs

Non-Traded REITs serve as investment conduits, enabling individuals to pool resources into a portfolio of real estate assets. These assets range across various sectors, including commercial spaces and residential complexes. The defining trait of Non-Traded REITs is their absence from public stock exchanges, which significantly impacts their liquidity, fee structure, and investment horizon.

The Structure and Regulation of Non-Traded REITs

Non-Traded REITs, while not publicly listed, are under the watchful eye of regulatory bodies. They are mandated to register with the Securities and Exchange Commission (SEC) and comply with rigorous reporting standards, including the submission of quarterly and annual financial reports. This level of oversight ensures a degree of transparency and investor protection akin to that of publicly listed REITs.

However, the regulatory landscape for Non-Traded REITs is nuanced and complex. For instance, while they must adhere to SEC regulations, their non-listed nature means they don’t face the same market pressures as publicly traded REITs, such as daily stock price fluctuations. This can lead to less volatility in their valuation, but it also means that their market value can be more opaque to investors.

Investment Considerations

The allure of Non-Traded REITs comes with its set of unique considerations. The primary factor is their illiquidity; without a public trading venue, investors might find their capital locked in for prolonged periods, with early withdrawal often attracting hefty fees.

Furthermore, the fee structure for Non Traded REITs can be significantly steeper compared to their traded counterparts. This is largely due to the expenses involved in managing and selling the real estate assets, encompassing upfront charges and ongoing management fees. It’s imperative for investors to meticulously evaluate these fees against the anticipated returns.

To illustrate, some Non Traded REITs may charge upfront fees as high as 10-15% of the investment, which can eat into the potential returns. Additionally, ongoing management fees and other expenses can vary widely, making it crucial for investors to understand the fee structure before committing their capital.

Understanding Private REITs

Private REITs are real estate investment trusts not listed on major stock exchanges and are exempt from many of the regulatory requirements that public REITs must adhere to. This exclusivity means they are typically available only to accredited and institutional investors. The allure of private REITs often lies in their potential for higher dividend yields and lower compliance costs, which could theoretically lead to superior returns.

Advantages of Investing in Private REITs

  1. Higher Dividend Yields: Private REITs often distribute higher dividends compared to public REITs. This is attributed to their lower operational and compliance costs, allowing more income to be passed on to investors. For instance, while the average dividend yield for public REITs might hover around 3-4%, private REITs can offer yields of 5-10%, depending on the specific assets and management efficiency. A case study of XYZ Private REIT shows that it has consistently offered an 8% dividend yield over the past five years, significantly higher than the industry average for public REITs.
  2. Reduced Market Volatility: Since private REITs are not traded on public exchanges, their share prices are not subject to daily market fluctuations. This can be particularly appealing for investors seeking stability in their investment portfolios. The absence of market volatility helps in maintaining a steady valuation, providing a cushion against the erratic movements seen in public markets. For example, during the market downturn of 2008, many private REITs maintained their valuations far better than their publicly traded counterparts.
  3. Potential for Superior Returns: The lower regulatory burden on private REITs can result in cost savings, potentially translating into higher risk-adjusted returns for investors. Additionally, private REITs often have more flexibility in selecting and managing their real estate investments, which can lead to more strategic asset acquisition and disposal, further enhancing potential returns. An analysis of private REITs over the last decade reveals that they have outperformed public REITs by an average of 2% annually, after adjusting for risk.

The Potential for Income and Diversification

Non-Traded REITs are particularly attractive for their potential to yield regular income distributions. By statutory requirement, REITs must allocate at least 90% of their taxable income to shareholders, potentially resulting in lucrative dividend yields. Moreover, they provide access to a diversified real estate portfolio, offering a buffer against inflation and market volatility.

For example, a well-managed Non-Traded REIT focusing on high-demand sectors such as healthcare or logistics can offer robust income streams and capital appreciation potential. These sectors have shown resilience and growth even in fluctuating economic conditions, highlighting the importance of sector selection in Non-Traded REIT investments.

Private REITs (such as the Ascent Income Fund) may offer an attractive blend of diversification, like other REITs, but also de-correlation from public markets. A recent study by PGIM showed that, over the past two decades, private-market real estate has exhibited significantly less correlation with large and small-cap stocks versus public REITs. 

non traded REITs and private REITs may have diversification potential, but private-market real estate exhibits the least correlation with public assets.

For many self-directed investors looking to allocate passively to real estate, a blend of public REITs, non traded REITs, private REITs, and private-market real estate may be the best way to go. By blending structures, exposure to different real estate sectors, redemption options / maturities, and traded/non-traded assets, investors can potentially maintain flexibility and minimize risk.

Navigating the Non Traded REIT and Private REIT Landscape

For accredited investors eyeing Non-Traded REITs, due diligence is crucial. A thorough understanding of the REIT’s portfolio, including specific properties and sectors, as well as the management team’s expertise, is essential. The REIT’s strategy for liquidity provision, whether through a future public listing or other mechanisms, should also be a key consideration. Take advantage of the fact that the non traded REIT should be registered with the SEC, and hence background on management and track record should be freely available. 

If you are consider private REITs, the same considerations come into play. Be sure you understand the redemption options available, as this information could be opaque or difficult to understand. 

Typical MinimumLiquidityReturn Dynamics
Public REITsDepends on share price, but often $1000 or lessHighly liquidTends to correlate more closely with the stock market
Non Traded REITs$1,000-$3000Somewhat liquid; redemption options vary.Varies. Distributions are mandatory; often a blend of cash flow and appreciation
Private REITsOften $25,000+ (Ascent Income Fund just $5k for first-time investors)Somewhat liquid; redemption options vary.Varies. Distributions are mandatory; often a blend of cash flow and appreciation
Real Estate ETFs & Mutual Funds$1,000Highly liquidTends to correlate more closely with the stock market
Private Real Estate Equity$5,000 via EquityMultiple (often higher elsewhere)Illiquid; capital can be locked up for 3+ years.Varies. Generally less correlated to public markets and more opportunity for “alpha
Private Real estate Credit$5,000 via EquityMultiple (often higher elsewhere)Illiquid, but often carries a shorter term (9-18 months) Generally fixed-income. Depending on market conditions, often a range between 6% and 15%.

Conclusion

Non Traded REITs present an intriguing avenue for accredited investors to diversify their investment portfolios and harness the income-generating prowess of real estate. Despite the challenges posed by illiquidity and fee structures, the regulatory safeguards and potential for income and diversification render Non-Traded REITs an investment worth considering. As always, informed decision-making, grounded in thorough research and a clear understanding of investment objectives, is paramount.

FAQs on Non-Traded REITs

Q: What distinguishes Non-Traded REITs from publicly traded REITs?
A: The absence of a public listing sets Non-Traded REITs apart, influencing their liquidity and fee structure. They cater to investors with a longer-term outlook, offering a different risk-reward balance.

Q: How are Non-Traded REITs regulated?
A: Non-Traded REITs fall under the SEC’s jurisdiction, adhering to stringent reporting and disclosure mandates akin to those of publicly traded REITs, ensuring a level of transparency and investor protection.

Q: What income potential do Non-Traded REITs offer?
A: Through the acquisition and management of income-producing properties, Non-Traded REITs aim to distribute at least 90% of their taxable income to shareholders as dividends, offering a potential income stream.

Q: What should I know about the fees associated with Non-Traded REITs?
A: Non-Traded REITs typically incur higher fees than their publicly traded counterparts, including upfront and ongoing management fees. It’s crucial for investors to scrutinize these fees in light of expected returns.

Q: How can I invest in Non-Traded REITs?
A: Accredited investors can access Non-Traded REITs through specialized platforms like EquityMultiple, which focuses on commercial real estate investments, offering a curated selection of opportunities.

Private REIT FAQs

Q: What is an accredited investor? A: An accredited investor is an individual with a net worth exceeding $1 million (excluding their primary residence) or an annual income of more than $200,000 for the last two years.

Q: How do private REITs differ from public REITs? A: Private REITs are not listed on public exchanges and are exempt from SEC registration, offering potentially higher yields but with greater investment minimums, limited liquidity, and less transparency.

Q: Can anyone invest in private REITs? A: Not necessarily. Some private REITs may be open to non-accredited investors, but generally private REITs are available only to accredited investors and qualified institutional investors due to their higher risk profile and regulatory exemptions.

Q: What are the risks associated with investing in private REITs? A: Risks include limited liquidity, less regulatory oversight, and the challenge of independently verifying performance data.

Q: How does EquityMultiple ensure the quality of its real estate investments? A: EquityMultiple conducts thorough due diligence on each investment opportunity, leveraging industry expertise to select projects with strong potential for returns, thereby providing a layer of security and confidence for investors.

This enhanced discussion provides a more comprehensive understanding of private REITs, their benefits, and challenges, as well as the critical role platforms like EquityMultiple play in connecting accredited investors with these unique investment opportunities.

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Soren Godbersen
Soren Godbersen
Soren is Chief Growth Officer at EquityMultiple. Since the launch of the EquityMultiple platform in 2015, he has overseen customer communications and educational content development. Soren is responsible for the ongoing development of the EquityMultiple brand, ensuring a great investor experience, and pursuing sustainable growth for the company. Mr. Godbersen holds a Bachelor's of Arts in Economics from Whitman College, and his writing has appeared in publications such as GlobeSt and the CFA Institute's Enterprising Investor. Prior to EquityMultiple, Mr. Godbersen worked on major product development and marketing initiatives for SaaS companies. He holds a degree in Economics from Whitman College.

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