In February 2016, I published an article that was not kind to non-traded or private real estate investment trusts (REITS). Unlike the traded variety that can be sold immediately on a public exchange, non-traded REITS have no public market if you want to liquidate the shares, making them much more illiquid. I contended that even though non-traded REITS had some theoretical benefits, the high fees and commissions, illiquidity, lack of transparency, and lack of a track record associated with them negate any advantage. My longstanding recommendation has been to stay with traded public REITS for your portfolio.
That article was picked up by Barron’s, where it was read by Tom Lonergan of JLL Income Property Trust. He agreed with me that most non-traded REITS did have all the negatives I listed, but pointed out that others did not. While I was skeptical, I decided to investigate further.
My investigation over the past year did turn up a handful of non-traded REITS that don’t pay a commission, have reasonable fees, have limited liquidity, offer transparency, and do have an existing portfolio of properties that offers an easily discernable track record. This article is my acknowledgement that not all non-traded REITS are equal.
First, why should you even care if real estate is in your portfolio? The biggest reason is that it’s the third largest asset class, behind bonds and stocks. Of all that real estate, about 7% is owned by public REITS. The remaining 93% is owned by publicly traded corporations, private partnerships and REITS, and individuals.
One of the strongest arguments for including a non-traded REIT in your portfolio is that it acts much more like directly owning real estate than a traded REIT. The big difference between non-traded and traded REITS is volatility. Traded REITS are more volatile than stocks. Traded REITS have a potential annual volatility (referred to as standard deviation) of 22%, while the stocks of large companies are 16%. A non-traded REIT has a volatility of around 2%, which is almost that of bonds at 3%.
Why the huge difference in non-traded and traded REITS when they are the same asset class? The answer is liquidity. With traded REITS, liquidity is both a major strength and an Achilles heel. Traded REITS are subject to public sentiment, just like stocks. Their price is driven by behavior. Since they are liquid and can be bought and sold in a nanosecond, their price can swing wildly. In this regard, traded REITS act more like a stock investment than a real estate investment.
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Non-traded REITS, just like rental houses or office buildings owned directly by an investor, can't be traded or liquidated quickly. The price of a non-traded REIT is set by the value of the properties that are owned, not public sentiment. That is why the share value of traded REITS dropped around 75% in 2009, while non-traded REITS dropped around 25%. The properties owned by the traded REITS didn’t decrease any more than the non-traded REITS, but the wholesale panic in the public exchanges dropped their share value three times more than the decline in the actual value of the real estate.
As with many things in life, when it comes to real estate we can’t have our cake and eat it too. One factor that makes real estate such a stable investment is that it is inherently illiquid. You can’t have both liquidity and low volatility. But you can have a non-traded REIT that has limited liquidity, a track record, with reasonable fees and no commission. However, you do have to look hard to find them.