Private Real Estate is a Better Alternative to Non-Traded Private REITs
As investors seek diversification from stocks, they’ve turned to non-traded real estate investment trusts, or REITs, whose shares don’t trade on exchanges. But many investment experts frown upon non-traded REITs because of subpar returns, high fees and risk, notes Bankrate.com. They also lack transparency and liquidity, as I wrote in an article published on TheStreet.com.
REITs are companies that own or finance income-producing real estate and are designed to provide investors with regular income streams, diversification and long-term capital appreciation, notes the National Association of Real Estate Investment Trusts (NAREIT). A REIT can include or focus on apartment complexes, shopping centers, office buildings and hotels, and can also be the manager for those properties. Non-traded REITs are registered with regulators but don’t trade on a national exchange.
Some financial advisers pitch public and non-traded REITs as low-risk, secure investments with steady annual returns. That explains why “annual fundraising by non-traded REITs more than tripled between 2009 and 2013 to a record $20 billion” and then declined to $15 billion in 2014, according to The Wall Street Journal.
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The Financial Industry Regulatory Authority (FINRA) just revised its consumer advice on public, non-traded REITs after fining one company $10 million for broad failures that included the sales of non-traded REITs. FINRA took special note of the front-end fees that can be as much as 15% of the share price. That covers sales compensation and expenses and additional offering costs such as marketing and administration.
Then, non-traded REITs can charge buyers for an array of fees that can further increase costs. According to a primer on non-traded REITs from Securities Litigation & Consulting Group (SLCG), these can include fees for acquisitions, asset and property management, real estate commissions, construction and more. This explains why the full cost of fees per share can range from 15 – 20%. FINRA’s guideline is that upfront fees should be capped at 15%. At Origin, we think that’s still way too high. Why would you make a $10,000 investment, when only $8,500 gets put to work?
Think about how much a property has to appreciate just to break even on those fees. According to the SLCG, many of the funds with high front-end fees have unreliable reported values and don’t catch up. In a recent study, SLCG found that investors have lost $45.5 billion by investing in 81 non-traded REITs, and “56% of the underperformance is due to the upfront fees that primarily compensate salesmen.”
An investor alert from the Securities and Exchange Commission issued in August 2015 calls out not only the high front-end fees but also real estate asset management fees and other charges. These deals can have built-in conflicts of interest: The same asset manager may get paid again through property management or leasing fees.
Plus, many of these deals are leveraged, which means there are loan origination and refinancing fees. This REIT fee frenzy goes on as long as one holds the investment — and then when the property is sold, the investor can expect a disposition fee for closing the account.
Origin’s real estate investments put investors’ money directly into private placement and eliminate these outrageous costs. For funds like Origin Fund III, the upfront fee was 1.5%, and the yearly asset management fee was 1.5%. Also, Origin hires independent property managers and negotiates performance-based fees. The fees for each of our deals in the fund were spelled out in the Fund’s investment summary and private placement memorandum available by requesting documents on our website. It’s not only more efficient, it’s more transparent. Investors know exactly what they are paying for, and the manager’s interests are aligned with theirs.
That’s especially true here at Origin, where Michael Episcope and I make significant investments in every deal as co-principals of the firm. Co-investment by the management team matters. How much of a non-traded REIT is fueled by the management team? We’ve funded 10 – 25% of our products historically. Each real estate crowdfunding platform has fee structures and exit participations, which vary widely. But by creating a more straightforward distribution channel, crowdfunding can put a higher percentage of every investor dollar into the property. At Origin, our efficiencies allow us to invest 97 – 98% of every dollar raised.
When investors see returns by private real estate at Origin, they’re real returns — not eaten up by fees.