Publications

- April 1, 2017; Vol. 4, Number 4

How to Invest in Public Nonlisted REITs

by Tony Chereso

Public nonlisted REITs (PNL REITs) are often discussed, yet widely misunderstood, income investments. For suitable investors, they can be a powerful portfolio diversifying investment. Since PNL REITs are sold almost exclusively through professional financial advisers, awareness of their diversification benefits and suitability are not as well known as other types of real estate investments.

Financial advisers have been recommending PNL REITs to their clients for more than 30 years. In fact, $135 billion was invested in PNL REITs between 2000 and 2016. Annual investment increased from $706 million in 2000, to a peak of approximately $20 billion in 2013. By 2016 sales had contracted, due primarily to increased regulatory uncertainty stemming from the Department of Labor’s proposed fiduciary rule and the related disruption to the product sales cycle. Nevertheless, PNL REITs have become an increasingly essential investment for more than 3 million individual investors, and 40,000 financial advisers have recommended PNL REITs for their clients’ portfolios.

HOW THEY WORK, HOW TO INVEST

Quite simply, PNL REITs enable individual investors to benefit from the potential income generation and capital appreciation that stems from commercial real estate assets. An investor can choose to receive regular distributions for current income, or reinvest them for longer term capital appreciation.

Independent broker dealers have historically been the primary distribution channel for PNL REITs, providing access to dozens of institutional asset managers that offer unique products and institutional real estate expertise.

The institutional asset managers make investments in accordance with a formal prospectus filed with the SEC, across all real estate asset classes: office, industrial, multifamily residential, retail, healthcare and assisted living, hotel, self-storage or commercial mortgages. Typically PNL REITs have an investment horizon of five to 10 years, with a focus on current income, preservation of capital and potential capital appreciation.

PNL REITs possess attributes that satisfy retail investment strategies in both general and retirement investment objectives. Because PNL REITs, like all REITs, are required to distribute no less than 90 percent of their taxable income, they represent an ideal investment for income-oriented investors such as retirees or investors nearing retirement age.

By investing directly in real assets, PNL REITs can help investors avoid over-concentrating their portfolios in exchange-traded securities or pooled investment vehicles that invest in exchange-traded securities and are subject to market volatility.

CLIENT SUITABILITY

In addition to performing customary due diligence — including a review of the management team, business plan and fees — financial advisers and their clients should review the prospectus before investing in a PNL REIT. The prospectus will clarify the investment term and explain the provisions for selling shares. It will also suggest potential exit strategies and specify minimum purchase requirements, along with any income and net-worth thresholds. Each PNL REIT has its own requirements.

It should be noted that there is a limited secondary market for PNL REITs and shares trade infrequently, though most programs have a share redemption plan where you may be able to resell your shares. This structure, however, enables the institutional asset managers sponsoring PNL REITs to execute long-term investment strategies and strategically manage their portfolios to meet stated objectives. They are not forced to react to market pressure but are able to leverage markets on behalf of their investors, not Wall Street.

PNL REITs generally have a lower correlation to asset classes such as stocks, bonds and cash, in which most individuals are invested. For long-term investors with diversified portfolios, an allocation to commercial real estate through PNL REITs can reduce their overall level of risk for a given level of return.

PLAYING THIS INSTRUMENT IN TODAY’S MARKET

Although most individuals have historically been unable to access prominent alternative investment vehicles such as hedge funds and private equity funds, today’s market is forcing advisers and investors to look harder for retail-accessible investments that offer true diversification, lower correlation and insulation from public market volatility. Today’s low-rate environment, political uncertainty and record-high equity markets mean the role of portfolio diversifying investments will only grow in importance.

PNL REITs represent a category of portfolio diversifying investments that offer active institutional management and institutional-quality strategies to the retail investor. Although this has been the case for many years, we are at a moment in time when retail and retirement investors are showing a greater propensity for alternative investments.

EXPANDING DISTRIBUTION CHANNELS

As products evolve and markets expand, the next generation of PNL REITs will continue adapting to the desires and needs of investors. The leading asset managers in the space have been proactive in lowering fees, creating investor-friendly share classes and increasing performance transparency through enhanced statement disclosures. These firms seek greater alignment of interests with their distribution channel partners and the end investor.

Blackstone Group’s recent entry into the PNL REIT marketplace has reminded financial advisers that these products can be an important ingredient of a well-diversified portfolio, particularly for investors seeking income-generation and low-correlation to traditional asset performance. Firms such as Jones Lang LaSalle, Cantor Fitzgerald and Morgan Stanley are also signaling an opportunity for broader wirehouse distribution.

With interest rates still near historic lows and equity markets at record highs, the world’s leading asset managers and wealth management firms believe there is going to be a demand for retail-friendly alternative investments such as PNL REITs.

Tony Chereso is president and CEO of the Investment Program Association.

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