For many people, owning real estate is one of the most desirable ways to invest their money. Yet, investing in real estate can be both complicated and expensive. This is especially true if you are interested in investing in commercial real estate or other income producing properties. Very few people can afford to buy commercial property all by themselves in order to rent it out as an investment.
What is a real estate investment trust (REIT)?
A real estate investment trust (REIT) is an entity that makes large-scale real estate investing more accessible to the general public. Essentially, an REIT is a company that owns a portfolio of real estate properties, and then offers shares to the general public. Still, while REITs are a good option for some investors, this product comes with many risks.
Here, the experienced REIT investment fraud attorneys at the Sonn Law Group, discuss some of the important things that all investors need to know about real estate investment trusts. We highlight the basics of how these financial products work and we also explain some of the dangers that investors need to watch out for when investing in REITs.
REITs: The Basics
In 1960, President Dwight Eisenhower signed the law that eventually led to the rise of REITs. The goal of the legislation was simple: establish a legal framework that gives investors access to large-scale income producing real estate projects. Today, REITs are everywhere. There are nearly 190 publicly-traded REITs, mostly listed on the New York Stock Exchange (NYSE), and another 1,100 REITs that are registered with the Securities and Exchange Commission (SEC), but that are not publicly traded.
The Different Real Estate Assets Owned By REITs
REITs own and control many different types of commercial, residential and industrial real estate property. Some of the most common examples of property that are owned within REITs include:
- Apartment buildings;
- Condo buildings;
- College housing;
- Hotels and motels;
- Hospitals and other medical facilities;
- Nursing homes;
- Industrial parks and manufacturing facilities;
- Infrastructure projects;
- Offices buildings; and
- Retail property such as shopping malls.
There are Equity REITs and Mortgage REITs
REITs fit into two categories: equity and mortgage. Equity REITs make up approximately 90 percent of the total market. These are the more traditional REITs, as they own and operate income producing real estate properties. The other 10 percent of REITs are known as ‘mortgage REITs,’ and they build their business around extending credit, acquiring real estate loans and purchasing mortgage backed securities.
There are Public Listed REITs and Non-Traded REITs
As was mentioned, some REITs are listed and traded on public stocks exchanges such as the NYSE. As these products can be traded, they are far more liquid than are private, unlisted REITs. While both traded and non-traded REITs come with risks, non-traded are much riskier on average, and are not appropriate for many investors.
Understanding the Risks of Investing in an REIT
Real estate investment trusts are simply not appropriate for all investors. Before your financial advisor recommends that you put your hard earned money into an REIT, they must ensure that it is truly right for your individual needs and desires. REITs, especially non-traded REITs, come with many different risks. Here, we highlight five of the risks that all investors need to be aware of before committing their money.
They Often Come With Large Upfront Fees
Non-traded REITs are notorious for coming with large upfront investments fees. Indeed, the front-end sales charges on these products often run above five percent, and the total fees can reach 15 percent or more. With fees this high, it can be difficult for an investment to be profitable, even if it does reasonably well.
At a minimum, all registered investment advisors have a professional obligation to ensure that they have clearly explained the total investment costs to their customers. If the fees related to your REIT purchase are substantially higher than you were informed, you may have a legal claim to seek compensation.
They are Unsuitable for Many Investors
Brokers must only recommend investment opportunities that are suitable for their client’s
individual investment profile. REITs are unsuitable investments for a large number of investors. The high fees, considerable risks and difficult nature of trading these products make them inappropriate investments for many people.
Non-Traded REITs are Illiquid
One of the biggest reasons that non-traded REITs are unsuitable for so many investors is that they are illiquid financial products. It can take a considerable amount of time to move in and out of these investments. Many investors need to have a portfolio that has retained sufficient liquidity so that quick action can be taken if something goes wrong or cash is needed.
Lack of Diversification
As REITs focus almost exclusively on real estate, overconcentration of investments becomes a major concern. When real estate prices drop, the entire market can fall all at once. Without proper diversification, this can cause tremendous problems for investors. Indeed, during the subprime mortgage crisis, which raged from 2007 through 2009, many REITs lost more than 50 percent of their total investment value. Portfolios that were not adequately diversified at this time crushed innocent investors.
A Conduit for Fraudsters
Finally, sadly, fraudsters have been known to use REITS as a lure to attract investors. Indeed, in some cases, REITs have even been used as the ‘hook’ in Ponzi schemes. For example, in 2016, a Texas REIT known as United Development Fund was delisted from the Nasdaq after the SEC launched an accounting fraud investigation into the company.
As REITs are extremely complex financial products, investors always need to be careful to ensure that they are putting their money into a legitimate fund. Registered financial brokers must always do their part by conducting adequate due diligence on any REIT products that they sell their clients.
Were You a Victim of Investment Fraud?
We can help. At Sonn Law Group, we have extensive experience handling claims involving Real Estate Investment Trusts. To request your free case evaluation, please call our team today at 844-689-5754. From our main office in South Florida, we represent investment fraud victims throughout the United States and around the globe.