Advisors looking for diversification and risk management strategies to protect their clients’ assets from losing value in volatile markets need not settle for just stocks and bonds. Michael Black, of the CCIM Institute, which educates commercial and investment real estate professionals, suggests real estate investment trusts, or REITs, are a valuable tool for stability and diversification in clients’ portfolios.
Although non-traded REITs have relatively limited liquidity, among the benefits of using non-traded REITs versus publicly traded REITs, according to Black, is that they lack the volatility normally encountered in the markets.
“By definition, the key benefit of non-traded REITs is that they are not yet publicly traded. Subsequently, they offer the reasonably predictable cash flow of publicly traded REITs without the volatility incumbent in the public markets.”
Furthermore, he says, “non-traded REITs receive the same tax benefits as publicly traded REITs. That is, by meeting certain requirements for taxable income distribution to shareholders, the REIT itself is not taxed, thereby reducing tax on the potential return on the investment.”
REITs are structured to allow common ownership of multiple properties, Black notes. The compelling difference between publicly traded and non-traded REITs, he says, is the balance between liquidity and market volatility.
“Assuming the REIT remains non-traded, the investor incurs a lack of liquidity since the primary outlet for selling shares is the REIT company itself (although one could find another investor to buy one’s shares),” according to Black. “However, as noted, reduced exposure to market volatility is an off-setting benefit. The reverse is true of publicly traded REITs: Investors gain increased liquidity, but increased volatility exposure as well.”
A counterbalance to the lack of market liquidity, Black says, is that “most non-traded REITs offer repurchase agreements” if an investor changes his mind before public listing. To cover acquisition and organizational costs incurred by the investor, the repurchase agreement will specify a discount, which will decrease over time as appreciation increases the property value, to the initial purchase price.
Black cites the dot-com craze as an example. “Investment dollars flooded the technology sector of the securities market, while publicly traded REITs traded at as much as a 40% discount to their actual NAV. As the mania faded from the technology revolution, publicly traded REIT prices rebounded to levels in the 0% to 6% discount range. Even though the price/NAV still is slightly negative, this rebound has resulted in high returns for investors who bought and sold at the right time.”