By Phillip Britt

Unlisted REITs offer Satisfaction for Some Investors

Some investors look to publicly registered, unlisted real estate companies for the benefits of real estate equity exposure without the apparent volatility of the public markets. In recent years, unlisted yet publicly registered real estate companies have seen a steady flow of capital.

"There's no lack of interest in the non-publicly traded sector," says Don Miller, chief real estate officer of Wells Real Estate Funds, Inc. "Close to 70 percent of our investors are re-investing their dividend to buy more shares."

Publicly registered, unlisted real estate companies are registered with the Securities and Exchange Commission (SEC) but not traded on any of the public exchanges.

The operators of these companies provide 10-Qs, 8-Ks and many of the other disclosures of a listed REIT. Critics of these investments say that notwithstanding the disclosures, the investments aren't valued on a real-time basis. Because they aren't traded, there's no market mechanism to price them. Sponsors of these investments carry the underlying assets at par, even though they may have declined or appreciated in value. So an investor who purchased $10,000 of these funds may have more or less in actual principal than the initial investment amount.

Some of the leading sponsors of unlisted companies include CNL Financial Group, Inland Real Estate Corporation, Wells Real Estate Funds and W.P. Carey & Co.

Peace of Mind

One of the selling points for investing in one of these real estate companies is the peace of mind for some investors that comes from being insulated from the gyrations of the public market.

Mark Zalatoris, chief operating officer for Inland, also says this format enables a company to build its asset base before bringing the concern public. After raising the initial funding through private placement, an unlisted real estate company needs to build earnings and re-invest those earnings in additional assets to continue to grow. In the case of Inland, the company grew to the point where it could be self-managed in 2000, meaning it no longer had to pay a management fee to an outside company, Zalatoris explains.

After continuing to grow and refine the business, the company reached a size for a public offering, and started trading on the New York Stock Exchange in June 2004 under the symbol IRC.

"Our goal was to provide a liquidity event," Zalatoris says, adding that starting as a private offering gives the company time to build to a sufficient size to attract institutional investors for a stock offering. Though there's no magic bullet as to when to have an initial public offering, the company's goal has been 10 years, Zalatoris adds.

Becoming a publicly traded company isn't the only option for liquidity. Other avenues include merging with another company that is publicly traded or a straight liquidation.

	Publicly Traded REITS	Unlisted REITs	Private REITs
Overview	REITs that file with the SEC and whose shares trade on national stock exchanges.	REITs that file with the SEC but whose shares do not trade on national stock exchanges.	REITs that are not registered with the SEC and whose shares do not trade on national stock exchanges.
Liquidity	Shares are listed and traded daily on stock exchanges with minimum liquidity standards.	Shares are not traded on public stock exchanges. Redemption programs for shares vary by company and are limited. Generally a minimum holding period for investment exists. Investor exit strategy generally linked to a required liquidation after some period of time (often 10 years) or, instead, the listing of the stock on a national stock exchange at such time.	Shares are not traded on public stock exchanges. Existence of, and terms of, any redemption programs varies by company and are generally limited in nature.
Transaction Costs	Broker commissions typically range between $20 and $150 per trade, depending on brokerage service. Investment banks receive a 2-7 percent fee to underwrite initial or follow-on offerings. Offering expenses vary based on deal size.	For each share purchased from the REIT, 10–15 percent of gross offering proceeds typically go to pay broker-dealer commissions, offering expenses and up-front acquisition or advisory fees (fees typically split between a related intermediary and third-party broker-dealer).	Varies by company.
Management	Typically self advised and self managed.	Typically externally advised and managed.	Typically externally advised and managed.
Minimum Investment Amount	One share.	Typically $1,000–$2,500.	Typically $1,000–$25,000; private REITs that are designed for institutional investors require a much higher minimum.
Independent Directors	Broker commissions typically range between $20 and $150 per trade, depending on brokerage service. Investment banks receive a 2-7 percent fee to underwrite initial or follow-on offerings. Offering expenses vary based on deal size.	For each share purchased from the REIT, 10–15 percent of gross offering proceeds typically go to pay broker-dealer commissions, offering expenses and up-front acquisition or advisory fees (fees typically split between a related intermediary and third-party broker-dealer).	Varies by company.
Management	Typically self advised and self managed.	Typically externally advised and managed.	Typically externally advised and managed.
Independent Directors	New stock exchange rules require a majority of directors to be independent of management. New NYSE and NASDAQ rules call for fully independent audit, nominating and compensation committees.	Subject to North American Securities Administrators Association (NASAA) regulations. NASAA rules require that boards consist of a majority of independent directors. NASAA rules also require that a majority of each board committee consist of independent directors.	Not required.
Investor Control	Investors re-elect directors.	Investors re-elect directors.	Investors re-elect directors.
Corporate Governance	Specific stock exchange rules on corporate governance.	Subject to state and NASAA regulations.	Not required
Disclosure Obligation	Required to make regular financial disclosures to the investment community, including quarterly and yearly audited financial results with accompanying filings to the SEC.	Required to make regular SEC disclosures, including quarterly and yearly financial reports.	Not required.
Performance Measurement	Numerous independent performance benchmarks available for tracking public REIT industry. Wide range of analyst reports available to the public.	No independent source of performance data available.	No public or independent source of performance data available.
Source: NAREIT

Bond Alternative

While waiting for the liquidity event, the Inland investors were earning a 6 percent to 7 percent annual dividend on their shares, which were first offered at $10, then subsequently at $11 per share. The current dividend yield on the public company was about 6.5 percent based on the Aug. 31, 2004 close of $14.80 per share.

The unlisted real estate companies don't position themselves against publicly traded stocks, but instead consider themselves as an alternative investment to bonds, which have seen declining yields over the last decade.

Though yields started to trend back up in 2004, rising yields usually means higher inflation, meaning companies can charge higher rents, Zalatoris says. Additionally, the yields of the non-publicly traded real estate companies, which were from 6 percent to 9 percent, were still running better than 2 percentage points ahead of Treasury Bills.

While the dividends and capital appreciation that Inland and some W.P. Carey funds have offered to their investors have provided decent returns, according to Barry Vinocur, publisher of Realty Stock Review, he and other critics aren't so sure about the format.

Illiquidity

Vinocur highlights two characteristics of unlisted REITs that investors need to be aware of in choosing their investment alternatives. He says the lack of liquidity that comes with unlisted REITs restricts the investor's ability to get his or her money back out of the unlisted company. Though an investor may be able to liquidate under special circumstances (e.g., death or disability) or may in some instances be able to sell the shares back to the company, the latter isn't guaranteed and comes with a significant penalty, much like a life insurance policy surrender charge. Otherwise, the investor needs to wait for a "liquidity event," which may be several years away. Therefore, these investments are designed for long-term (about 10 years) investors, and only about 5 percent to 10 percent of an investor's portfolio, according to company sponsors and brokers who sell the investments.

Another issue tied to these investments are the initial fees, running up to 15 percent (including broker commissions of 8 percent to 10 percent).

Where to Buy

It's easy enough for investors to find unlisted REITs. A few brokerage firms, like A.G. Edwards, UBS Warburg and Paine Webber include them as part of their portfolios of investments. Independent financial planners and brokers also offer unlisted REITs.

Wells offers schools to teach financial planners, pension plan advisors and other financial consultants about the nuances of its unlisted REITs, real estate limited partnerships, like-kind exchanges and other real estate investments. Wells, like many other companies offering non-exchange traded REITs, provides other real estate services as well.

Donna Beers, senior managing director and investment advisor with The Private Consulting Group, who sells Wells' non-traded offerings to her clients, says the typical buyer is a high net worth client or pension fund looking for an income investment and portfolio diversification.

According to Miller, the typical buyer has net worth (exclusive of home, home furnishings and autos) of $150,000; or a net worth (as described above) of at least $45,000 combined with a current gross income of at least $45,000. Broker/dealers will also have limits imposed as to how much of an investor's portfolio can be allocated to any one product.

Vinocur questions some of the financial planners who sell these investments because they earn higher commissions, typically 8 percent to 10 percent, for selling the non-publicly traded real estate companies than they do for selling many other investments. Some may not fully disclose this to potential customers, Vinocur says.

Beers counters that an ethical financial planner will indeed discuss the commissions earned for selling such investments. She adds that the commission is collected one time. If on the other hand, one of her clients was to purchase an investment without an up-front commission, the yearly management fee would be 1 percent. So, over a 10-year period, the investor would eventually pay more in management fees than he would for the initial commission.

So while the investments have some detractors, they are the right vehicles for at least a portion of a targeted investor's income, according to Beers. Investors will likely be able to choose from more companies offering these funds in the future as brokerage firms and others consider offering unlisted investments to their customers.