Unlisted REIT’s Are Not What You Think They Are

When you really dig into unlisted REIT investments, you realize they are not what you think they are.

REIT stands for Real Estate Investment Trust. These are companies that own a lot of real estate. Listed REIT’s trade over exchanges just like most other types of companies, and there are mutual funds made up many REIT’s all pooled together, just like mutual funds of any other stock.

Not too complicated, right? I use REIT mutual funds for my clients all the time.

Unlisted REIT’s are different, and they have been creeping up in popularity lately. These are REIT’s that are so new, they haven’t started trading publicly over an exchange yet. Investors in these become the original seed money to get the REIT going. Down the road, the pool might sell out to a private company or might go public.

Because they aren’t traded over an exchange, you don’t see the price fluctuate, although these are usually revalued on a quarterly basis. This has been couched as a positive – that you don’t see the price fluctuate. But that really is all it is. You don’t see the fluctuations, but the risk is still there behind the scenes. Not much of an advantage in my book.

BTW, most REIT’s have taken quite a hit in the past month. My prediction – next time a lot of these unlisted REIT’s report their valuations, a lot of investors will be in for a rude awakening.

Really a lousy bond with a little upside kicker

These REIT’s usually offer to pay the investors roughly 7% interest on the money until the REIT goes public or is sold. Most investors mistakenly believe that this 7% is rent. Well, it is sort of rent. The company often needs rental income to pay this 7%, but it isn’t directly tied to the amount of rental income received. What is this 7% really? It is the cost for capital this company pays to investors to raise cash for its operations.

Wait, haven’t I heard of that before…..hmmm….a contract where a company pays a fixed interest rate to investors to get money for operations.  Oh yeah, that is a bond.

In fact, unlisted REIT’s basically are bonds — that is, bonds secured by a tiny real estate investment company. Oh wait, there is one difference. With a bond, you know when you will get back your principal. With these non-listed REIT’s, it is up to borrower’s discretion on when to pay back investors, usually 3 to 10 years or so. So with an unlisted REIT you really have a bizarre bond with an undefined maturity (up to the pleasure of the borrower) secured by a tiny real estate company. Doesn’t sound quite so attractive anymore, does it.

To be fair, there is one other upside to the investor. If there is upside above 7% when the REIT is sold or goes public, this additional money is split between the REIT company and the investor. This is just the equivalent of a call option.

To recap, an investment in an unlisted REIT is really a bond with an undefined maturity, secured by a small real estate company, generally at a 7% interest rate, along with the equivalent of a call option on the company.

This is far from how most families understand these investments. They think they are buying solid real estate investments and getting the rent. In reality, they are buying very obscure financial instruments.

Photo by The Consumerist