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Nontraded REITs go mainstream

By Sheyna Steiner ·
Monday, January 14, 2013
Posted: 6 pm ET

At the beginning of January, a first-ever situation was reported: Bank of America Merrill Lynch had begun offering a nontraded real estate investment trust, or REIT, to investment advisory clients in November.

The move is significant because nontraded REITs have been the province of independent broker-dealers; the fact that Bank of America is wading into the pond is a nod to the increasing popularity of the real estate investments.

Why are they popular?

REITs are corporations, trusts or associations that own commercial real estate. Publicly traded REITs are registered investments that trade on an exchange while nontraded REITs are, as the name implies, not traded on an exchange.

"The REIT investment itself gives the individual the opportunity to invest in quality real estate assets, which traditionally are reserved for institutional investors," says Charles Schreiber, CEO of KBS Capital Advisors.

"An investor who is investing $30,000 or $40,000 has an opportunity to be an investor in a $60 million, $100 million or $140 million commercial office project or a portfolio of apartments that traditionally through a small investment club they wouldn't have the opportunity to invest in," he says.

Nontraded REITs have grown in popularity, thanks to dividend yields and low correlation to the stock market. Liquidity is scarce, however; investors in nontraded REITs are typically going to wait several years to get their principal back, and getting out early can be difficult and expensive. Publicly traded REITs, on the other hand, are easy to get in and out of and are priced daily.

The value of nontraded REITs is assessed on a yearly basis.

"That assessment is more of an assessment of real estate value, not the value of the security. It is really less impacted by the activities in capital markets, such as the securities market," Schrieber says.

That low correlation with the stock market is attractive to investors still scarred from 2008. But the valuation has proved problematic. Last summer, the Financial Industry Regulatory Authority, or FINRA, released an alert to investors to thoroughly investigate any nontraded REIT investments.

Most nontraded REITS are structured as a "finite life investment," meaning that at the end of a given timeframe, the REIT is required either to list on a national securities exchange or liquidate. Even if a liquidity event takes place, there is no guarantee that the value of your investment will have gone up -- and it may go down or lose all its value. Indeed, valuation of non-traded REITS is complex. Many factors affect the pricing, including the portfolio of real estate assets owned, strength of the trust's balance sheet (assets versus liabilities), overhead expenses, cost of capital and more. The boards and managers of non-traded REITs might even rely on third-party sources to estimate a per-share value.

"There is a growing trend and growing sensitivity on the transparency of reporting. The initial topic is really valuation, but I think that this matter will continue to improve," Schreiber says.

Have you had any experience with nontraded REITs? Do you think you're interested?

Follow me on Twitter: @SheynaSteiner.

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