As equity markets continue to sputter along at an uneven pace, an increasing number of investors have begun to look at alternative investment vehicles in an attempt to help manage volatility as well as to potentially generate more steady and predictable income. One such alternative investment over the years has been commercial real estate, which during the economic booms of the late 90s and early 2000s was an attractive asset class to many.
A vehicle that allows investors to gain exposure to commercial real estate is the non-traded real estate investment trust (REIT). Over the past several years, however, non-traded REITs have gained a questionable reputation, causing many investors and wealth managers to shy away from them entirely. Undeniably, there have been specific players within the non-traded REIT industry that have earned that poor reputation, having not performed well in terms of returns, transparency and disclosure. That said, investors and wealth managers should still consider non-traded REITs for the following key reasons:
Diversification - Generally speaking, portfolios should have a diverse set of holdings, including investments that are expected to be inversely correlated to equity markets. While it's important to note that non-traded REITs do not provide inverse correlation in the tradition sense, they are historically much less correlated to equity markets as a whole.
Many non-traded REITs encompass multiple properties across diverse geographies spanning many different real estate sectors, including retail, health care, commercial, residential and industrial. Therefore, while investors could choose non-traded REITs that are sub sector specific, they do provide the opportunity to gain collective exposure to multiple sub sectors of real estate
Provide Strong Alternative to Publicly Traded REITs - Many investors seek exposure to investments that are expected to be less correlated to the broader equity markets through publicly traded REITs. Unfortunately, this strategy doesn't always work. While it's possible to get exposure to commercial real estate via publicly traded REITs, the non-traded REIT market is historically far less correlated and less volatile. This is because the stock value of publicly traded REITs is subject to multiple forces beyond the value and occupancy of commercial real estate, such as broader market dynamics and trading on a day-to-day basis.
Non-traded REITs Can Potentially Yield Relatively Higher Level of Income - This is historically true versus traded REITs. According to Bloomberg, the NAREIT REIT dividend yield of the NAREIT index at the end of June was 3.46%.
Certainly the greatest issues surrounding non-traded REITs revolve around liquidity, a relatively high front-end fee structure and a lack of transparency by some of the companies that sponsor them, and for these reasons many wealth managers remain wary of them.
While a small number of non-traded REITs are beginning to allow a greater level of liquidity access for investors than has been the industry standard in the past, for those who need immediate access to cash, non-traded REITs generally remain an unsuitable investment option. However, for those investors willing to pay up-front fees and give up liquidity, non-traded REITs continue to be an attractive, viable asset class because they have the potential to achieve higher returns down the road.
Transparency and disclosure concerns are just as important but can potentially be overcome when the wealth manager takes the initiative to establish due diligence procedures that identify well managed, high-quality non-traded REIT investment opportunities. The following are five due diligence steps we believe wealth managers should take before recommending an appropriate non-trade REIT as an investment vehicle for their client:
1. Only consider well-established players - You want to consider industry veterans who have achieved critical mass and have gone through at least one or two full real estate life cycles, from the initial property acquisition to a liquidity event at the end. No matter how talented the non-traded REIT team may be, how well-funded they are and how compelling their strategy, the actual experience of going through at least one or two full real estate life cycles as an organization is of paramount importance.
2. Look at how the non-traded REIT has handled past failures - No one has been immune to the headwinds in the real estate industry of the last several years, so you want to see how certain players have navigated failure. Specifically, did the players you are looking at make a concerted effort to execute a comprehensive workout plan that affected some measure of shareholder recovery, however minimal?
3. Ensure accessibility of the executive team - It's typical for REIT companies to invite interested wealth managers to their offices for due diligence trips. Bear in mind that these trips tend to be sales driven more and that the wholesaler by the very nature of his or her job will not likely be 'hands on' with your relationship once the sale has been made. Therefore, from the outset it's important to determine who is making the executive decisions at the non-traded REIT and whether they will be frequently and regularly accessible after the purchase is made on behalf of the client.
4. Seek second opinions from specialty third-party research groups - There is a small universe of investment research firms who have years of experience doing deep dives and kicking the tires of non-traded REIT companies. These firms can sometimes be costly, but it's worth the initial investment to help to better inform the decision making process. These third-party research groups include Blue Vault, MTS Research and The Non-Traded REIT Report put out by Snyder Kearney LLC, among others/
5. Look for proactive communications and transparency - Companies should proactively provide an array of communication beyond basic regulatory filings, including quarterly calls and emails that keep wealth managers and investors up to date. Ask about their investor communications process and what their disclosure calendar looks like in as much detail as possible.
The non-traded REIT industry has taken a justifiable reputational hit over the past few years, but that doesn't mean that the industry as a whole should be written off. They are absolutely suitable investment vehicles to use for certain clients, and one of the overriding strategic priorities in such instances is to establish the right due diligence process.
Tim MicKey is Managing Director of Monument Wealth Management (www.monumentwm.com), a Washington DC-area based wealth management firm that helps accomplished entrepreneurs transition to a life of long-term financial independence and wealth defined on their own terms.
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