You may not be surprised to know that there is a steady stream of salesman that come through our doors talking about their mutual funds, exchange-traded-funds (ETFs) and other products that they want us to buy on your behalf.
The vast, vast majority of meetings do not sway how we invest your money, but I do like to listen just in case there is something out there that we haven’t uncovered and that’s worth pursuing. Also, the salesmen serve as a bit of a devil’s advocate since they try to convince us that what they are offering is better than what we are doing.
Within the last few months, a wholesaler (industry jargon for salesman) came into the office to talk about non-traded REITs. We like and use REITs (click here for more), but haven’t bought non-traded REITs.
Traded or non-traded, REITs are simply companies that own commercial real estate that are required to pay 90 percent of the income that they receive to shareholders. Both types are registered with the Securities and Exchange Commission (SEC) and are required to make regular disclosures, including filing a prospectus, quarterly and annual reports (10-Qs and 10-Ks).
Despite these similarities, the investor experience can be quite different. As their name implies, non-traded REITs are not publicly traded companies, which means that they are illiquid and you may not be able to sell a non-traded REIT easily and get your money back.
In our view, that’s enough of a reason not to buy non-traded REITs. We prefer that all of our investments are liquid. Of course, small bond positions can be hard to sell and sometimes everything is illiquid, like in 2008, but for the most part, everything that we own can be sold at the market price.
People are willing to buy non-traded REITS and forego liquidity because volatility is low and the yields are high. We find flaws in both of those stated benefits.
Non-traded REITs have low volatility because there is no market price and the fund manager gets to put a price on the fund. Valuation is a difficult proposition in general, but when the person who gets paid based on the value of the investment is setting the value, an obvious conflict of interest exists.
The second benefit, the high yield, is also problematic. In today’s low interest rate environment, a six or eight percent yield can seem pretty enticing. As always, yield is only one part of total return.
According to the Wall Street Journal, one study by Securities Litigation looked at the performance of 27 non-traded REITs that had gone through the entire cycle of raising money, buying properties and then winding down the fund and found that the average annual return was 5.2 percent, compared with 11.9 percent for an index fund from Vanguard that tracks publicly traded REITs.
An industry spokesman said that the study was flawed and I don’t know either way, but the point is that a high yield isn’t sufficient to justify an illiquid investment if the total return doesn’t match what we can buy in the public markets.
We’ve been leery of non-traded REITs because they carry very high fees – as much as 15 percent of the initial investment. The ongoing costs can also be expensive because the fund sponsor usually takes a management fee and 20 percent of the profits.
Right now, I’m especially glad that we didn’t participate in any non-traded REITs because the largest sponsor, Realty Capital Securities, is under criminal investigation for accounting irregularities.
It will take time to determine whether there was any wrongdoing or not, but it’s satisfying to know that we don’t have any exposure – and that even if we did, we could sell out immediately, albeit at lower prices.
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I am heading to the Charles Schwab Annual IMPACT conference. This will be my 12th or 13th trip and I always get something out of it. I often say that it’s like a vacation for me because I go to a nice city, stay in a nice hotel, eat good meals and all anyone wants to talk about is investing!
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