What is a Non-Listed REIT?
Non-listed REITs, publicly-registered, non-listed real estate investment trusts (REITs), are a popular investment vehicle that requires close scrutiny.
While they are often criticized as an expensive and illiquid type of investment that affords little, if any, disclosure to the investor, non-listed REITs1 have become an increasing popular investment in this period of low interest rates. On their face, non-listed REITs offer attractive dividends and the potential for capital gains. Indeed, many billions of dollars have been invested in non-listed REITs. Often, non-listed REITs issue their shares at a fixed price which is not subject to fluctuation because the non-listed REITs do not trade their shares on a recognized securities exchange. Despite the fact that these are illiquid investments, their proponents tout them as a good choice for the long term investor because they are not subject to market volatility.
Most non-listed REITs promise a fixed dividend of 6% to 8% per year. However, many investors do not realize that a substantial percentage of their investment (usually 15% -20%) actually pays for sales commissions and fees, leaving a lesser amount for property investment. Because of the attractive sales commissions, these investments are often aggressively promoted by brokers and financial advisers.
In order to remain qualified as a REIT for federal income tax purposes and thereby avoid paying excise tax on undistributed income, a REIT must distribute a large percentage (currently 90%) of its taxable income annually. The high costs of acquiring real estate, coupled with the fact that often only 80%-85% of invested funds are actually available for this purpose, often results in a non-listed REIT’s inability to pay dividends out of its operating cash flow. The articles of incorporation for some non-listed REITs provide that if there is insufficient cash flow to meet the distribution requirement, funds for that purpose may be generated through other means including loans, cash reserves, the issuance of new securities or the sale of assets. Analysis of the dividends paid by non-listed REITs reflects that over time, an increasing percentage of the dividend is comprised of a return of investor capital.
Often the articles of incorporation for non-listed REITs include provisions offering some measure of liquidity for investors. Some authorize a share redemption program, often subject to numerous limitations as well as the discretion of the board of directors to change the program. Others contain provisions requiring the REIT to list its shares on a national securities exchange by some specific date in the future or be required to liquidate its assets. Again, these provisions may not assure liquidity as they may be subject to the board’s decision.
The representation of investors who purchased non-listed REITs is a growing area of practice for Chimicles & Tikellis LLP.
Related article: Non-Listed REITs - Yield Heaven or a Bad Dream?
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1 For example, in the first seven months of 2004, it was estimated that over $3.7 billion had been invested in non-listed REITs marketed by the none largest non-listed REIT sponsors. Further, at least eight companies are in the process of obtaining the approval of the Securities and Exchange Commission to make initial public offering for non-listed REITs. See Direct Investments Spectrum, July/August 2004 at pages 2-3.