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Types and Risks of REITs Explained

Real Estate Investment Trust (REIT). Non-Traded or Non-exchange REITs.

last update Thursday, October 20, 2022





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What is a real estate investment trust?

Real estate investment trusts or REITs are companies that own and operate income-producing real estate or related assets. Assets include office buildings, apartment buildings, hotels, warehouses, mortgages, loans, etc.
The REIT's purpose is to buy or develop properties and operate them as part of its own investment portfolio.
REITs provide a way for an investor to earn a share of the income produced through real estate or related assets ownership. The REIT's investor doesn’t need to buy commercial real estate themselves. By owning shares of the REITs investors receive the most benefits from owning real estate.

Two main types of REITs.

REITs that are registered with the SEC and are publicly traded on a stock exchange are known as publicly-traded REITs. Others that may be registered with the SEC but are not publicly traded are known as Non-Traded or Non-exchange REITs. Before investing in a REIT, you need to understand whether or not it is publicly traded and how it could affect your investment portfolio.

What are the risks of REITs?

The benefit of REITs is that it offers a way to include real estate in your investment portfolio. Some REITs may offer higher dividend yields than other investments.
However, there are some risks, especially with non-traded REITs:

  1. Liquidity of REITs. Publicly-traded REITs have "regular" liquidity as any publicly traded securities. At the same time, Non-exchange REITs investments can’t be sold easily. If you need to sell to get quick money, a non-traded REIT wouldn’t be a good choice for you. You are maybe locked in for months or years.
  1. The Value of Share. While the market price of publicly traded REITs is accessible and defined by the market as any publicly trades security, non-traded REITs don’t give access in terms of determining the value of a share. Non-traded REITs do not provide an estimate of their value per share until 18 months after their offering closes. This means you aren’t going to assess the value and volatility immediately after investing.
  1. Although non-traded REITs offer high dividend yields compared to publicly traded REITs, it frequently pays distributions over their funds from operation. To do that, they may use offering proceeds and borrowing. This practice reduces the value of the shares and the cash available to the company for purchasing extra assets.
  1. Conflict of interest. Non-traded REITs have an external manager instead of their employees and this can lead to potential conflicts of interest with the shareholders.

Buying and selling REITs. 

You can invest (buy or sell) in a publicly-traded REIT by purchasing shares through a broker. Similarly, you can purchase shares of a non-traded REIT through a broker that takes part in the non-traded REIT’s offering. You can also buy shares in REIT mutual funds or exchange-traded funds.

REIT's fees and Tax considerations.

You can purchase the common stock, preferred stock, or debt security of a publicly-traded REIT through a broker. However, brokerage fees will apply for that. Non-traded REITs are not sold by a regular broker. It has high up-front fees. Sales commissions and upfront fees usually sum up to approximately  9 to 10 percent of the investment.

Most REITs are paying 100% of their taxable income to their shareholders. The REIT's shareholders are responsible for paying the tax on the dividends and any capital they gain with their investments. Dividends paid by REITs are treated as ordinary income and are not entitled to reduce tax rates on other types of corporate dividends. Always consult your tax adviser before investing.

You can verify the registration of both publicly traded and non-traded REITs using SEC’s EDGAR system. You can also use it to review a REIT’s annual and quarterly reports as well as any offering prospectus.

Related FAQ

Are REITs riskier than stocks?

REITs have enjoyed lower volatility compared to stocks. Still, REITs can experience significant price volatility, especially over short periods of time.

Can you lose money in REIT?

As with any investment, there is always a risk of loss.

Does Warren Buffett recommend REITs?

Warren Buffett tends to favor real estate investment trusts, companies that own or operate different properties. Warren Buffett doesn't favor investment in physical real estate.

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