Living It Up at the Hotel California

When it comes to privately offered REITs, checking out at the price you see on paper may be hard to do. I recently looked at a very interesting investment security that allows an individual to own a stake in commercial real estate. In general, there’s nothing unusual or unique at all about securities that invest in real estate. They’ve been around for years. They are called real estate investment trusts, more commonly known as “REITs.”  The real estate investment security that I have recently looked at, however, is not a commonly owned, publicly traded variety, but rather a privately offered REIT.

It turns out that there are a number of interesting aspects of these private REITs. For example, unlike most publicly traded REITs that understandably have shown a decline in share price commensurate with the difficulties that real estate is having — the Standard & Poor’s composite real estate investment trust index declined roughly 58 percent in 2008 — many of these private REITs have amazingly not bobbled or lost so much as a penny in reported value on client account statements. Wow.

I like a good deal as much as anybody, so that really caught my eye. As you might imagine, I wondered how, in the worst real estate market of the last 80 years, these private REITs have somehow been able to walk on water. I guess all the stupid real estate managers must work for the publicly traded firms.

So I wanted to know more. I dug a little deeper and here’s a bit of what I learned: Private REITs are of course not required to register with the Securities and Exchange Commission. They’re private.

At first, that concerned me, but then I thought, well, maybe that’s OK. After all, you can imagine how annoying the SEC can be — what with all the disclosure and financial filings its regularly requires.

While there have been a few problems in recent years with securities outside of the jurisdiction of the SEC, an absence of SEC oversight certainly does not, in and of itself, tell you whether they are a good deal for the investor. They certainly could be. But there’s at least one party in this transaction for whom they are a great deal: the broker who sells them. You see, I discovered that the brokerage commissions realized for these private REITs can be as high as 25 percent. No wonder they’re so popular. Now I’m thinking I want some of that.

I also learned they — again because they are private — don’t trade on any public stock exchange. I guess I could see where that might be OK too. Sort of. After all, why would you want a stock exchange involved for a security that you hold in your investment portfolio? It really shouldn’t matter to you — unless by chance you should need to sell your investment in this, REIT before it winds down. If for some reason you do need to sell early, you generally have to make that redemption request directly to the board of directors of the trust. And it turns out that redemption request may, or may not be, honored timely. It depends on the rules as outlined in the initial offering circular. You do carefully read all of your offering documents, don’t you?

And here’s another thing I learned: Since the value of a private REIT has no public auction market to set a daily share price (like a stock does), it’s not real clear what the true value of a private REIT is once it has been sitting in your investment portfolio. Now true enough, some sort of a value will be reported — often the initial purchase price — on an account statement. But given the upheavals in the real estate market over the last few years, to imagine that an investment in real estate has not changed in value so much as a nickel requires either a suspension of belief of the facts or a herculean leap of faith. But who knows, maybe all of the managers in the world of private REITs have truly been able to do a yeoman’s job because they are from, say, Lake Woebegone — where everyone is above average.

So there you are. In the most difficult investment climate of the last 80 years, there is at least one investment that seemingly is perfect. Amazingly, it appears to hold its full value and has very generous commissions paid to the selling broker. Most important, so long as you are not too concerned with the real underlying value of what you are holding, it seems to provide just the right amount of warm fuzzy that so many folks are looking for in these stressful times. After all, that lack of liquidity and disclosure thing would seem to be annoyances at best.

OK, enough of the tongue-in-cheek. If you want to invest in a diversified portfolio of real estate, know this: There are many publicly-traded REITs that address all spectra of the real estate market. They pay generous dividends, can be bought with no onerous commission attached, have full and continuous disclosure through publicly filed financial statements, and they are fully liquid. Not a bad group of attributes. But after considering the pros and cons of both sides of the real estate investment securities market, if for some reason you still have a compelling need to own an illiquid, non-publicly traded real estate investment security, read the disclosure document fully and carefully. If you are not sure what you are looking at, have a qualified adviser or accountant carefully review the offering documents before you write the check. It’s important.

Like the Hotel California, where you can check out, but you can never leave, the devil in this case truly is in the details