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These REITs Are Just Not RIGHT

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There are REITs, and then there are REITs. And some of the latter are the kind you will want to keep at arm's length. I'm referring to the non-traded kind of REIT. You may not have heard of non-traded REITs. I hadn't until recently, but when I did, alarm bells started going off.

REIT 101
REIT stands for real estate investment trust. It is a form of equity that allows investors to own shares in a group of real estate investments. A big draw for investors is that REITs must, by law, return at least 90% of their earnings (if any) to investors in the form of dividends.

That structure can make for some healthy dividends, such as Annaly Capital Management (NYSE: NLY  ) , a government agency mortgage-bond-buying REIT that presently yields 14.4%; or Health Care REIT (NYSE: HCN  ) , which develops health-care properties and has a yield of 5.3%; or Government Properties Income Trust (NYSE: GOV  ) , which buys office space and yields 6.6%.

REITs like those list on a stock exchange and trade like any other equity. Their share prices go up and down with the vagaries of the market. They may make money (hooray!); they may lose money (darn!); but whether they gain or lose, the investor will always know their market values.

Not so with non-traded REITs. Those prices are set at their initial offerings, and that's pretty much where they stay. Non-traded REIT marketers tout that price stability as a great advantage for volatility-wary investors. The reality, however, is much different.

The problem is illiquidity. What if the non-traded REIT has no cash to buy back shares? A stable price means zilch if investors can't sell. Since the shares aren't listed on an exchange, you're out of luck there, too. I guess one could try eBay or Craigslist.

High dividend rates are another dubious selling point for non-traded REITs. When an investor considers total returns, those non-traded REIT dividends could just disappear. Upfront fees of 9%-10% -- sometimes as high as 17% -- can wipe out most of those dividend returns. Also, consider that of the 90 non-traded REITs approved by the SEC since 1990, only 13 have returned investors' capital.

There are also problems of transparency. Michael McTiernan, a lawyer with the SEC, told The Wall Street Journal, "We believe investors would benefit from more information how [non-traded REITs] reach their valuations." If they don't get that information, he said, "[The industry] ... should expect to hear from us."

And then there is the question of overaggressive marketing. The Financial Industry Regulatory Authority, or Finra, accused David Lerner Associates of misleading investors in its marketing of its non-traded Apple REIT.

Buyer beware
The lure of high yields combined with low volatility has helped sales of non-traded REITs proliferate, with $73 billion worth in the last decade alone. But like anything that looks too good to be true, one should take several hard looks before jumping in. But I just can't find one good reason to buy into a non-traded REIT -- especially when there are plenty of traded ones to choose from.

Fool contributor Dan Radovsky owns shares of Annaly Capital Management. The Motley Fool owns shares of Annaly Capital Management. Motley Fool newsletter services have recommended buying shares of Health Care REIT. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 25, 2011, at 5:50 PM, dbtheonly wrote:

    Just for it, how does one go about buying a non-traded REIT? If it's not traded then there is no track record, no listing price history, no readily available source of financials.

  • Report this Comment On July 25, 2011, at 6:55 PM, XMFDRadovsky wrote:

    I believe these are marketed by so-called financial advisors or brokers. Buyer beware.


  • Report this Comment On July 26, 2011, at 5:20 PM, phyk18940 wrote:

    Wow! so good to no. Recently at a financial planner tell me I didn't have enough assets to purchase REITS and was shocked when I mentioned I owned some in my portfolio, looked at me like I had two heads. Thanks so much for this info. Challenge those advisors, they are in it to make the most money they can even if they say they have your interest as first.......One advisor tried to convince me I needed to put a deferred annuity in a tax deferred account, talked to me like I was an idiot, he continues to put a deferred annnuity into another deferred account, he is rated a high rated but

  • Report this Comment On July 27, 2011, at 3:30 AM, gjrjar wrote:

    Could you let me know source of the statement "of the 90 non-traded REITs approved by the SEC since 1990, only 13 have returned investors' capital."?

  • Report this Comment On August 14, 2011, at 9:16 AM, XMFDRadovsky wrote:

    Sorry, I didn't see this comment until today. The source for that statement was:


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