Commercial Real Estate (“CRE”) has been one of the best-performing sectors over the long term, both in terms of producing income and total returns. Allocating a portion of one’s investment portfolio to non-listed CRE is a prudent way to counter the volatility of publicly traded stocks, mutual funds and ETFs, as well as hedge against inflation. Yet until now, small- and medium-sized investors have had few avenues available to invest in the sector.
Prior to the launch of CAPFUNDR, the primary option for small and medium-sized investors has been Non-Traded REITS. These companies own real estate similar to public REITs but are not listed on an exchange. Non-Traded REITs charge very high fees that severely depress net returns to investors, even if the REIT’s investments are performing well.
Most Non-Traded REITS have performed poorly for the following reasons:
- They charge extremely high upfront loads and management fees, typically a 15% load of the initial investment.
- Transaction fees and expense reimbursements of 4-6% (3-4 times that of institutional-style annual management fees).
- They promise high dividends of 6-8% but these dividends are paid from return of capital, not from income. Because of the high fees, even a property that produces good returns cannot produce enough income to sustain the promised returns.
- Until new regulations are enacted in April 2016, investors in Non-Traded REITs are usually kept in the dark about the true net asset value (‘NAV') of the share prices. The NAV is reported at the initial offering price without taking into account all of the fees.
- Because they are not listed on an exchange, they are extremely illiquid.
- Most are externally managed, which often leads to conflicts of interests.
Institutional Real Estate Funds vs. Non-Traded REITs
This is how much of your investment in an institutional real estate fund and in a Non-Traded REIT will be left to invest in properties after paying offering fees and expenses, acquisition fees, and financing fees.
If both the institutional fund and the Non-Traded REIT are buying a property that generates a 10% current return, this is how much will be left to distribute to investors after ongoing management and other fees. Non-Traded REITs often receive reimbursements for management overhead in addition to their management fees.
Additional Investment Alternatives
In addition to Non-Traded REITs, there are some additional options but they all have their limitations.
Crowdfunded Individual Deals. Crowdfund sites that offer investors’ access to commercial property equity and debt investments are popping up on the Internet. This type of crowdfunding does in fact provide individuals access to commercial properties. But the properties tend to be small and in the lower quality end of the spectrum. What’s more:
- Investors in crowdfund sites are expected to do their own deal analysis, which is beyond the capability of most individual investors.
- Due diligence on most platforms appears to be limited and most lack the real estate experience to effectively analyze deals.
Direct Investments. Individuals can buy their own properties, assuming they have access to good deals. Some of the drawbacks include:
- Commercial properties require a large equity investment that few individuals can afford.
- Properties are management-intensive. Few individuals have the management expertise needed to successfully operate commercial properties.
- Unless the individual has the means to create a large portfolio, risk is concentrated in a handful of assets.
Public REITs. Individuals can buy publicly-listed, exchange-traded REITs, which provide access to institutional-quality real estate, typically concentrated by property type and geography. REITs are extremely liquid and have performed well over time mirroring the performance of the overall equities/stock market. The downside to public REITs include:
- They are relatively volatile and subject to noise in the larger equity market. Prices rise and fall based on market sentiment, not just real estate fundamentals.
- In many periods, REITs trade at a market value that is lower than the total net asset value (NAV) of the owned property portfolio.
Real Estate vs. Stocks vs. REIT Stocks
REIT Mutual Funds. REIT mutual funds, depending on their investment strategy, can offer broader diversification than investing directly in REITs. They also have the benefit of professional portfolio management and research. Investors purchase mutual fund shares, or units, which are bought or redeemed at the fund’s current net asset value (NAV). NAVs are calculated once a day and are based on the closing prices of the securities in the fund’s portfolio.
- Returns may be reduced by management fees if the manager does not outperform market returns.
- REIT mutual funds are subject to the same market forces (i.e., daily stock market share price fluctuations) as individual REITs.
REIT ETFs. REIT exchange-traded funds (ETFs) offer a low-cost investment option for investors seeking exposure to REITs. REIT ETFs own baskets of REIT stocks, and like other ETFs, REIT ETFs are designed to mirror an underlying REIT index. REIT ETFs have real-time net asset value (NAV) pricing, unlike REIT mutual funds which have NAVs calculated once a day, based on the closing prices of each security.
- They have lower management fees than mutual funds.
- Since they are not actively managed, they are not able to react to changes in valuation and strategy of the underlying REITs.
- REIT ETFs are subject to the same market forces (i.e., daily stock market share price fluctuations) as individual REITs.