The Wall Street Journal issue of March 25, 2015 had an article describing the reduction of returns and plight facing private REITs (REITs that are not publicly traded). This article prompted the question as to whether or not private REITs were or are a good idea as an alternative real estate investment alternative.
Starting at the end, it is suggested that for various and sundry reasons, private REITs probably were not and are not a good idea.
One of the major disadvantages of owning real estate is its relative lack of liquidity. Investing in the traditional publically traded REIT security had and has investment attractiveness because the investor is able to sell his or her position, in the public market, in a matter of minutes, at a market driven price, with the cash proceeds delivered within days. This is not true of investments in private REITs. Thus, the private REIT becomes somewhat similar to the old master limited partnerships but, without the MLP advantage of being able to pass through depreciation (tax shelter) directly to the investor on an annual basis.
As the article noted, there was a risk that private REITs overpaid for the portfolios that they acquired. That risk is somewhat universal wherever the acquiring entity is essentially a money manager acting for a group of investors or stockholders. Two factors probably “drive that boat”. First, there is a pressure to invest followed by a “herd mentality”. Whenever attractive properties hit the market a competitive buying frenzy usually results when conditions are as they now are where there is substantially more demand (money) competing for very few qualified properties. The investing environment is very different than competition between individual buyers investing their own money. In the case of individual buyers there is a tendency to worry about the risks leading to a more conservative approach. As an individual investor once remarked “even when I lie to myself with the numbers they just don’t work. Aggressive purchasing is validated if, and only if, values rise over time but there is no certainty of that happening.
The article also pointed out that investors in private REITs were disappointed by the slow pace of selling off property. Where the portfolio is in the hands of someone who is essentially a money manager, selling off assets is tantamount to “selling yourself out of a job”. Unless the money manager is a very major investor in the REIT his or her goals may not be the same as the investor’s goals. Because of this there is a potential conflict of interest risk between the investor and manager.
While the general conclusion is that investing in private REITs may not be the best idea there are transaction structures that could eliminate or ameliorate the observed negatives. As with any investment, there is no substitute for a thorough investigation and analysis as well as asking questions before becoming committed.