The non tradable REITs have the same qualifications as exchange traded REITs (REIT blog: http://paulsgang.blogspot.com/2010/07/reits.html).
The following are the major qualifications of REITs:
• Pay dividends of at least 90% of the REIT’s taxable income
• Have shares of transferable certificates of interest
• Owned by 100 or more persons
• At least 75% of their total investment must be in real estate
• Have at least 95% of gross income from dividends, mortgage income or property income
• Derive at least 75% of gross income from mortgage interest or rents
The major difference between tradable and non tradable REITs is the first are traded on a stock exchange and the second are not. You can sell tradable REITs like any other stock which makes them liquid. You know the value of your investment at any time.
The first major problem with non tradable REITs is they are not traded on stock exchanges which make them illiquid. You can only sell non tradable REIT shares to the REIT company that you bought them from if they have a stock repurchase program, or on a secondary market. If a non tradable REIT has a stock repurchase program, it may impose restrictions that can make it barely more liquid than a REIT without a stock repurchase program. Such restrictions might include: you can only sell the shares after a number years of owning them, some non tradable REITs will only buy back a percentage of outstanding shares (for example 5%) and they can stop the stock repurchase plan at any time. During the current real estate financial crisis many of the largest non tradable REITs have suspended their repurchase programs. Inland American is one of the non tradable REITs that have done this. The only way you can sell your shares in on the secondary market.
The second problem is that non tradable REITs have high upfront cost (sales commission). The upfront cost can be as high as 15% (on the other hand the purchase cost of tradable REITs can be as little as $5 per trade). For example, if you purchase $100,000 of a non tradable REIT, your financial advisor just made $15,000 (it is very difficult to be unbiased when you are being paid a very high commission).
Inland American is the eighth largest retail real estate owner in the United States, located in 47 states with managed assets of $25.3 billion. Currently they pay a 5% dividend yield, reduced from a 6.2% dividend yield in January 2009. Inland American stopped their stock repurchase plan in March 2009. The Inland American shares were bought for $10 in 2005. After checking several non tradable REIT secondary market companies, the highest price they were willing to pay for the shares was $4. In 6 six years the investment has taken a 60% ‘haircut’ (loss) in the value of Inland American shares. The company that buys the shares on the secondary market would get a 12.5% dividend yield.
There are much better investments for your income generating bucket of money for example, short term (duration) bond funds, annuities (for example a gift annuity that includes a tax free portion), etc. An illiquid investment carries higher risks than a liquid one; this becomes exacerbated during times of financial problems/crises. The investment becomes much more difficult to unload, or you can only do so by losing a lot of money on it. The high upfront cost is another problem - it is hard to swallow paying somebody 15% for their ‘financial advice’ (how unbiased can you be when you are getting such a hefty commission?).
You should be very careful when you invest in non tradable REITs and - like all investments - you need to understand the advantages and disadvantages of the investment. In 6 six years the value of the Inland American investment dropped 60% for a 5% dividend yield. I question if my relative’s ‘financial advisor’ ever talked about the disadvantages of non tradable REITs, my assumption is he only talked about the 6.2% dividend yield.
The following are some of Paul’s Gang recommended financial and investment books. If you are interested, you can select the link and get a review of the books from the Amazon website:
The Ascent of Money: A Financial History of the World
The Big Short: Inside the Doomsday Machine
Common Stocks and Uncommon Profits and Other Writings (Wiley Investment Classics)
Die Broke: A Radical Four-Part Financial Plan
The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History
The Intelligent Investor: The Classic Text on Value Investing
The Millionaire Mind
One Up On Wall Street : How To Use What You Already Know To Make Money In The Market
Security Analysis: The Classic 1934 Edition
Please chime in with comments about non tradable REITs. What are your favorite financial and investment books, ideas for future blogs, etc.? Future blogs that I will be will be writing:
• Evaluating NetFlix stock
• Income generating bucket of money
• Investing in possible buyout companies
© 2010 Paul Cusick
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