What do CNL Lifestyle Properties, Inland American Real Estate Trust and Behringer Harvard Multifamily REIT I all have in common? They are among a few dozen so-called non-traded real estate investment trusts, which are not listed on any stock exchange but are regulated by the Securities and Exchange Commission and the National Association of Securities Dealers.

Non-traded REITs — also referred to as unlisted REITs — are gaining favor with small investors, who for a minimum investment of as little as $1,000 hope to realize hefty returns. While most of the profit potential in unlisted REITs is at the end of a multi-year term, recently liquidated unlisted REITs have given investors the equivalent of 7.3% to 16.6% in annualized returns, according to Robert A. Stanger & Co., an investment banking firm that tracks the sector.

Insulated from stock market volatility that has hamstrung equity REITs for nearly two years, non-traded REITs raised approximately $10 billion in 2008, according to market watcher Stanger. In the past six years, investors have pumped $46 billion into the sector.

“There's a strong appetite for this product out there among individual investors,” says Kevin Gannon, managing director of Shrewsbury, N.J.-based Stanger. “Both real estate management companies as well as some publicly traded REITs are talking to us about entering this space as a means to raise capital.”

Buying power

Continued access to capital is probably the No. 1 advantage unlisted REITs offer today, says Byron Carlock Jr., president and CEO at CNL Lifestyle Properties. The Orlando-based unlisted REIT specializes in the acquisition of ski, mountain and golf recreational destinations.

Late last year, CNL acquired three ski and mountain assets in a sale-leaseback purchase from resort operator Triple Peaks. The deal included Triple Peaks' assets in Okemo, Vt., Crested Butte, Colo. and Mount Sunapee, N.H.

“What we've been doing is buying with cash and leveraging later if the debt is not available at closing time,” Carlock explains. “However, right now we are also sitting on plenty of cash reserves to weather the current environment.” CNL reported more than $300 million in cash reserves in its third-quarter 2008 report.

Individual investors buy shares of unlisted REITs through a broker/dealer with the expectation of retaining those shares and collecting a dividend until a liquidation event, typically after seven to 10 years. The front-end load that includes broker commissions and other fees varies, but averages approximately 15% of the invested amount.

Unlisted REITs generally pay out an annual dividend between 5% and 9%, and overall returns depend on proceeds of the final liquidation. Based on an analysis of seven funds that had reached liquidation by the end of 2007, Stanger found that the average investor earned a 64% return over hold periods that averaged five years. That's a return rate of about 12.5% on an annualized basis.

Minimal volatility

The price per share in untraded REITs is fixed at about $10, so investors don't have a reason to delay buying into an unlisted REIT in hopes that prices will drop. That contrasts with publicly traded REITs, where price volatility has deterred many investors from purchasing shares because they believe that prices have further to fall.

“It's harder for both companies and investors to get comfortable with stock offerings,” says Steve Marks, managing director in the New York office of Fitch Ratings. “Given the volatility, many investors may just want to wait for the stock to go lower.”

The bear market has choked capital flows and caused total returns for publicly traded REITs to drop 57% from their peak in February 2007 through early January 2009, according to the U.S. REIT index published by MSCI Inc., formerly Morgan Stanley Capital International.

In 2008 alone, total returns for publicly traded REITs plummeted 37.97%, their worst year ever, according to Barry Vinocur, editor of REIT Wrap, a daily electronic publication covering the equity REIT industry. “This is unprecedented,” he says. “In the little over 20 years that I've been covering the REIT space, I've never seen anything like what we're seeing right now.”

Unlisted REITs are using their strong cash positions to snap up deals while the credit crunch has thinned the ranks of competing buyers. In December, Inland American Real Estate Trust combined its cash with the assumption of the seller's mortgage to purchase the U.S. headquarters campus of drugmaker Sanofi-Aventis in Bridgewater, N.J., for $230 million. The Oak Brook, Ill.-based REIT raised more than $2.3 billion in investor capital in 2008, the most of any untraded REIT, according to Stanger.

Acquisition volume is down across the investor spectrum, but unlisted REITs have retained more momentum than other investor groups. Acquisition volume for unlisted REITs fell 51% in 2008, according to New York-based Real Capital Analytics. While that's a significant decrease in purchasing activity, it pales in comparison to the 70% drop in property acquisitions for traded REITs, and more than 80% for pension funds and institutional investors in 2008.

Unlisted REITs are “the one group that is buying into this market,” says Dan Fasulo, managing director at Real Capital Analytics. “They have been able, amazingly, to raise money in this environment.”

Illiquidity pays in this case

Unlisted REITs owe much of their recent strength to their shareholders' inability to quickly liquidate shares on an exchange. Some untraded REITs will buy back shares at a discount, but the companies aren't subjected to the sort of widespread selloffs by fearful investors that have beaten down REIT stocks.

Removed from the volatility on Wall Street, untraded REITs continue to attract investors and generate capital at a time when declining share prices have chilled investment in equity REITs, according to Martel Day, president of the Investment Program Association, a trade organization for direct investment companies, most of which are unlisted REITs.

“That has enabled them to purchase assets in the current environment, when real estate prices are depressed and cap rates have increased,” says Day, who also is director of business development at Oak Brook, Ill.-based Inland Securities Corp.

Ironically, the illiquidity that has left unlisted REITs flush with investor capital is one of the chief objects of criticism aimed at the sector. The model is designed to generate a profit for investors through a portfolio liquidation at the end of the investment term, not from the sale of shares before that date.

Before investing in an unlisted REIT, investors should determine whether they are prepared to park their capital in one place until a liquidation event occurs several years down the road, according to Nicholas Schorsch, chairman and CEO at American Realty Capital Trust, a non-traded REIT that invests primarily in freestanding, net-leased retail properties.

Liquidation can take the form of a portfolio sale or merger with another entity, a public offering, or a property-by-property selloff, with proceeds distributed among investors.

Investors who want to borrow on margin against their shares, or who seek a profit based on short-term appreciation, may not be a good fit for the untraded space, Schorsch says. “That's a tough conversation to have with investors.”

James Mattox, chief administrative officer at Addison, Texas-based Behringer Harvard, points to the positive side of investors' inability to trade unlisted REIT shares on an exchange: Upheaval on Wall Street doesn't drag down an unlisted REIT's value position through its share prices.


“The compelling fact about the non-traded REITs is that you don't have to endure that [volatility] as an investor,” Mattox says. “Rumor, speculation and that sort of thing isn't part of the experience.” Behringer Harvard sponsors two unlisted REITs, one focused on multifamily assets and another that invests in a variety of commercial properties.

Without the distraction of share price volatility, investors can focus on long-term goals that best complement the gradual appreciation potential of income-producing properties, according to Schorsch. “It gets the investor focused on the right thing: Are you going to make money for me long term, and is that platform the right relationship for me?”

Points of contention

Recent volatility aside, however, share prices provide an important benchmark for investors, according to REIT Wrap's Vinocur, who is an outspoken critic of the unlisted REIT structure. In the absence of daily trading, investors have fewer tools to help determine whether a particular REIT is right for them.

Vinocur says equity REIT share prices suggest that underlying real estate values have declined by as much as 35% since early 2007. That market-wide depreciation will eventually show up in unlisted REITs, he says, when those companies come to the end of their investment term and attempt to liquidate at market prices.

“The fact that your stock doesn't trade daily doesn't mean you escape the value drop; it only means the investor can't see the value drop,” claims Vinocur.

Despite the current turmoil enveloping publicly traded REITs, Vinocur maintains that investors are better off buying shares in a listed REIT rather than a non-listed one. Specifically, he believes the upfront fees or load in unlisted REITs cost the investor more than a similar purchase of REIT stocks.

Proponents of unlisted REITs say the one-time fee paid to buy into an unlisted REIT for a hold period of seven to 10 years may be similar to the cumulative cost of investing in REIT stocks over the same period, when annual costs such as management fees are factored in.

Vinocur also points to a dearth of analyst coverage for unlisted REITs as a disadvantage that deprives investors of insight that is available for traded REITs. The lack of analyst coverage is a legitimate concern, but the sector is making headway, according to Day of the Investment Program Association.

Sector maturity

Both Stanger and the Bank of Montreal have analysts following unlisted REITs, and more analysts will likely step into the sector as it matures. “We want that universe to expand,” Day says.

Proponents of unlisted REITs say their companies provide as much transparency as listed REITs through quarterly data, transaction summaries and other public filings. Offerings by unlisted REITs also are required to be reviewed by securities authorities at the state level, which provides an additional layer of government oversight that isn't extended to listed REITs.

Schorsch predicts the current global capital crisis among listed companies will accelerate investment in untraded REITs and lead to growth in the sector. “This industry has really come into its own,” he says.

The Investment Program Association and other proponents of untraded REITs are working to educate investors and investment advisors about the differences between the two REIT models. Day says investors frequently ask which is the better investment type.

“The reality is that they are both excellent vehicles for investing in real estate, and they have slightly different purposes,” Day says. “Both traded and non-traded REITs have a valuable place in a diversified portfolio.”

— Matt Hudgins is an Austin writer.