The Revolution in Non-Traded REITS
In what seems like a perpetually low-interest-rate environment, investors are on the hunt for products that offer both strong yield and tolerable risk parameters. Non-traded REITs have been put forward as a solution to these variables.
But let’s be honest. Despite their high and relatively secure returns, up until now, non-traded REITs have had their critics.
This is because they are widely regarded as a high-commission product. While they are prized by investors for their relatively consistent rate of returns, they also enrich the independent broker dealers who underwrite them and the army of financial advisors who sell them through their sky-high commissions. More than a few financial commentators have referred to them as a product made to be “sold, not bought.” It’s easy to see why. With upfront fees of up to 15 percent, it’s unlikely that anyone would actively seek them out but it’s easy to understand why financial advisors would be selling them.
The upfront fees embedded in many of these products mean that, for a $100,000 investment, only $85,000 is actually put to work earning returns. This not only puts investors in a sizeable hole from the start, it results in lost potential returns over the life of the investment. One study estimated that $15 billion in upfront fees paid by non-traded REIT investors would have grown to $25 billion over the course of the investment. Moreover, as sales of non-traded REITs have risen over the past decade, so has a chorus of criticism focused on conflicts of interests and a lack of transparency.
Non-traded REITs, it should also be noted, pose investment risks that are different from publicly-traded REITs. While they are registered and file regular reports with the SEC, non-traded REITS are illiquid investments, not listed on an exchange and not publicly traded. Share valuation is based on periodic appraisals of the properties owned rather than on market price. Investors generally must wait until a non-traded REIT lists its shares on an exchange or liquidates its assets to achieve liquidity.
But in a low interest rate environment, how can a yield-seeking investor ignore the significant opportunities these products can offer? After all, REITs offer the potential benefits of commercial real estate investment – stable income, potential capital appreciation, portfolio diversification – by giving them access to a pool of commercial real estate investments in a single investment. In a perfect world, non-traded REITs would provide retail investors with the same benefit that institutional investors receive from private real estate funds: a low-fee means to invest in real estate, uncorrelated to the stock market and therefore with limited volatility.
Fortunately, there have been changes in the investment marketplace that have begun to offer smaller investors cost-effective access to these benefits. Over the last few years and across the investment landscape, technology has brought about a sea of change that is proving to be an answer to problematic distribution channels used for non-traded REITs and the high fees that come with them.
Crowdfunding has effectively democratized investment: until recently, private investment markets have been off-limits to the majority of retail investors. Legislation like Regulation A+ and Title III of the JOBS Act has leveled the playing field by allowing non-accredited investors making less than $200,000 per year to access some of these investment opportunities through online crowdfunding.
Crowdfunding, which directly connects buyers and sellers, provides a potentially better way for investors to access products like non-traded REITs. It improves the non-traded REIT by maintaining the benefits of the product while significantly reducing the cost to investors. Rather than selling these non-traded REITs through an army of middle men, crowdfunding platforms can go direct to the investor.
Real estate crowdfunding platforms that have, up to now, built successful online marketplaces for investing in specific commercial real estate projects provide a possible better venue for investing in REITs. They can utilize a plethora of inbound inquiries for financing on commercial real estate to source and select suitable investment opportunities and construct a diversified portfolio. They also have the infrastructure and technology in place to provide investors with transparency about transactions and investment performance. Real estate crowdfunding platforms depend on their reputation for providing good, transparent investment opportunities to attract investors.
Conversely, the pool of investors who utilize these platforms attracts quality investments. A platform that becomes known for shoddy investments or hidden costs or risks will unravel quickly. The existential importance of reputation to crowdfunding platforms is an embedded feature that motivates investor-friendly transparency and clean business practices.
More to the point, by going direct to investors over the internet, online crowdfunding platforms can offer investors the full upside of non-traded REITs with much lower fees.
We’ve seen successful examples of this before. Amazon, eBay and other similar companies have utilized the Internet and evolving technology to bypass the middleman and bring goods to consumers at lower prices. But crowdfunding, as applied to certain investments, can be an even more compelling proposition.
Real estate crowdfunding has opened the vast commercial real estate market to individual investors by providing them access to vetted, single property investment opportunities. Crowdfunded REITs are a natural extension, providing investors access to a portfolio of commercial real estate investments in a single investment. By translating cost savings into lower fees for investors, crowdfunding makes non-traded REITs, up until now too expensive to be a great investment, a much better option for individual investors. Crowdfunding can create a new investment category for retail investors, a low-fee non-traded REIT – a people’s REIT, you could say – that provides retail investors with something previously available only to institutions: a fee-conscious means to invest in a commercial real estate portfolio without the volatility of public markets.