Real estate is an important part of a portfolio; it can provide diversification against stock market volatility, and inflation adjusted income and growth.
In choosing what vehicles to use for a real estate allocation, it is important to understand the upside benefits for the increased risk taken. The downside of taking on personal liability with direct ownership of a single should be a significantly positive return over simply investing in the broad real estate market.
Non-traded REITs are a popular real estate choice among commissioned brokers, the products pay high commissions, and claim to offer higher yields than many competing products (though a significant portion of that “yield” can be return of your principal rather than of gain). The problem with non-traded REITs? There are no significant benefits to these funds to justify their use over alternatives.
Niche play versus diversification
In order to create a demand, most non-traded REITs create their portfolios around a niche they hope will do well: senior or student housing, resorts and leisure, recession-resistant commercial properties, etc. While the niche may make for interesting sales stories about unique properties, when it comes to investment benefits it simply means these REITs receive some points for style, but have very little investment quality substance.
With real estate, just as with investing in the stock market, owning a niche is rarely preferred over simply owning the broad market. And unlike sector strategies in stock or marketable REIT investing, you can’t get out of your non-traded REIT if that sector or if the firm goes bad (and they have).
One reason to take on the above risks would be the opportunity for outsized returns. Unfortunately, the retail non-traded REIT industry has a very poor record, and it’s even worse considering the headaches they have caused investors and advisors haven’t led to increased gains. In fact, they only breakeven before costs.
A 2012 study by the University of Texas at Austin and BlueVault Partners found that before fees “non-traded REITs performed fairly similarly to their benchmarks.” After fees they trailed by about 1.4%. This number will vary based on the REIT, as many of the expenses for investors are front-loaded at the time of sale, representing the commissions paid in selling the product. Investors often have additional expenses to hold these funds in IRA accounts not taken into account by the study.
In light of all of the downsides investors should perform a significant review of the fees, conflicts of interest, and fit within their portfolio before buying the stories non-traded REITs sell. Sales brochures and regular postcards showing exotic golf course properties owned across the world are cute, but they are simply another expense you as investor pay to recruit new investors. Like most investments, the simplest and lowest costing approach is often the best; passive, high quality mutual funds provide exposure to real estate without the downsides of non-traded REITs.
The preceding blog was originally published by Forbes. To view the original blog please visit our blog at Forbes. http://www.forbes.com/sites/feeonlyplanner/