Private REIT vs Public REIT. The risks of Publicly Traded and Non-Traded REITS.

Before considering investing in REITs, you need to know the risks incorporated.

last updated Tuesday, November 28, 2023
#private reit vs public reit #Risks of Investing in REITs

John Burson

Real Estate Investment Trust (REIT) and Its Risks

CONTENTS

What is REIT?

REITs or Real Estate Investment Trusts are investment companies that generate income for the passive investor. REITs own and operate income-generating real estate that is paid in dividends.

REITs are not required to pay corporate income taxes like public companies. The revenue is only taxed after shareholders have received their revenue share. REITs make a great investment opportunity for investors as they generate income from owning real estate property. However, there are certain risk factors connected with REITs that you should know before investing.

Before considering investing in REITs, you need to know the risks incorporated. When investing in REITs through a broker, the broker needs to disclose the risks of the REIT investments. There are two types of REITS - Publicly traded and Non-traded REITs. Each one has a set of risks.

What is Public REIT?

A REIT, or Real Estate Investment Trust, is a type of investment vehicle that owns and operates income-generating real estate. REITs must distribute at least 90% of their taxable income to shareholders as dividends, making them an attractive investment for people looking for a steady income stream.
Public REITs are traded on stock exchanges, meaning their shares can be bought and sold by investors just like any publicly traded company.

What is a Private REIT?

On the other hand, private REITs are not traded on stock exchanges and are typically only available to accredited investors.

Risks of Publicly Traded REITs, Public REITs.

Leverage Risk. When an investor uses borrowed money to purchase securities, the leverage risk surfaces and the use of leverage causes the REIT to incite additional expenses while increasing the fund’s losses due to the underperformance of underlying investments. The other costs of the loan or borrowing will lessen the amount of money available for distribution to the company’s shareholders.
Market Risk. REITs trade on major stock exchanges and thus are subject to market price fluctuations. This implies that the investors may receive less than what they paid in the first place if they sell their shares in the public exchange. Recession, natural disasters, changes in interest rates, etc., maybe some risk factors.
Interest Rate Risk. Investors look for safe income plays, such as U.S. Treasury, when interest rates rise. Treasuries pay a fixed rate of interest and are guaranteed by the government. Therefore, when the rate rises, REITs sell off, and the bond market rallies as investment capital flows into bonds. This reduces the demand for REITs in the market.
Tax Treatment. REIT dividends are taxed as ordinary income, which means the regular income tax rate is similar to the investor’s income tax rate. These taxes are likely higher than dividend tax rates and capital gains taxes for stock.

Risk of Non-Traded REITs. Private REITs.

Liquidity Risk. Non-traded REITs allow investors to sell their shares on the public exchange market. Despite the allowance, the investments are illiquid compared to other assets, such as bonds and stocks. There isn’t a secondary market for seeking buyers and sellers for the property you would invest in. Also, liquidity is only provided through the fund’s repurchase offers. There is no guarantee that the shareholders leaving their investments will be able to sell all or fragments of the shares they want to sell. For liquidity reasons, investors may be unable to convert stocks into cash whenever needed.
Share Value. Non-traded REITs aren’t publicly traded, so the investors won’t be allowed to research their investments. As a result, it becomes relatively difficult to determine the Value of REITs. Some non-traded REITs reveal all assets after 18 months of their offering, but it’s pointless.
Upfront Fees. The upfront fee is charged between 9% to 15%. Apart from an upfront fee, non-traded REITs can have external manager fees. Hiring an external manager reduces investor returns. If you choose to invest in such REITs, it’s better to ask the management all the essential questions before you invest.

Investing in REITs can be a passive way to produce income instead of buying a property directly. But investors should also keep in mind not to be influenced by more significant dividend rates since REITs can perform low in the market even if the interest rate flares up.