Nontraded REITs may be an attractive choice for clients trying to build a steady stream of income, but a study by Cornell's Center for Hospitality Research found they may not bring the returns you expect in the long term. According to the study, REITs' fixed share price means "early investors subsidize the commissions paid to the dealers who sell to late-term investors." Dividends are sometimes higher than the amount of cash an REIT took in; vague exit plans and restrictive redemption policies also limit nontraded REITs' effectiveness. The authors offer a general checklist for clients interested in investing in nontraded REITs:
- Study the track record of the company and management.
- Read prospectuses and focus on fees, dividend payments, return of capital and risks.
- Examine the fee structure. Before investing money, investors should have a clear understanding of how much of their money will be invested in real estate and how much will be extracted for fees.
- Review dividend payment policies. Before investing money, investors should have clear understanding of conditions under which the sponsor can discontinue dividend payments.
- Clarify exit strategies. Make sure clients understand the options available to the sponsor for selling real estate at the scheduled end point of the investment period.
- Study tax regulations. For most investors, tax treatments are the same regardless of whether the REIT lists or does not list shares.
- Evaluate holding periods. The fixed share price allows investors to rest easy about day-to-day changes in share prices. However, investing early in the scheduled investment period exposes these investors to wealth transfer when real estate prices are increasing. Investors may consider the length of time the investment is open and, if possible, delay commitments until late in this period.