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Commercial Income Property and the Dangers of Buying Through REIT’s

the disadvantages of REITs

Investing in REIT properties may seem like a good way to get started in investing in commercial real estate, especially if you don’t have millions to invest. REIT’s which stand for Real Estate Investment Trust are funded by a group of investors who put their money together to buy and sell real estate.

Dividends are collected monthly or quarterly, and taxes -including capital gains taxes – still apply. REIT’s typically last between five to ten years, after properties are sold and the profits distributed amongst investors.

With REITS and other crowdfunding platforms popping up daily, some first-time investors choose REITS hoping to make higher profits despite their inherent volatility. However, all they seem like an ideal way of diversifying your portfolio while spreading the risk of owning investment property between a group of people, the truth is that REIT’s present a fair number of risks for uninformed investors.

REITs have a fixed maturity and must be sold regardless of market conditions.

There is a quite a bit of pressure for REIT managers to get the highest price possible for a property. However, what happens when properties bought at the height of the real estate market are sold now – especially when the market is lower (in general) than when they were originally bought? Obviously the REIT manager won’t want investors to lose money, since investors would leave.

Instead, some REIT managers choose to sell the property at an artificially inflated price, which you the investor end up paying, since you won’t be directly involved in the selling of the property.

The other problem that arises is that because REITs become mature after such a short period of time, they must constantly refinance their holdings in order to retain ownership of the asset. They are essentially using a short-term liability -debt -to finance a long-term asset- property.

If for any reason they find themselves unable to re-finance a property then the REIT will find themselves suddenly forced to add additional funds to save the property, or divest themselves of the investment at less than market value.

You could end up buying and selling a property to yourself – and lose money in the bargain.

REIT’s have become incredibly popular, and as a result, the market is exceptionally crowded. Pension funds, insurance companies, and foundations are some of the largest corporations that are investing in REIT’s, crowding out other buyers and playing havoc with the market. That’s because with so much money to invest, managers would rather invest in several big deals rather than hundreds of smaller (and potentially less profitable) ones.

However, it’s quite common for one firm to manage several REITs, which means it’s quite possible your manager will end up buying or selling a property to a REIT they already own. This of course, means they get paid on both ends – but you lose on both the purchase and the sale. The REIT property managers, on the other hand, end up being flush with plenty of cash to plow into another property. It also means you can’t guarantee that the property was bought or sold at the best price, since the manager is not an impartial party.

You can’t always investigate the property yourself.

Admittedly due diligence isn’t a walk in the park. However it’s the best way of making sure you purchase a property with a high chance of making you a profit… which is after all the name of the game. However non-traded REITs don’t make their numbers available to the public.

The other problem with non-traded REITs is that they can’t be sold before a seven year period have passed. If you want to cash in your investment earlier, you will pay a fee. This is done to discourage investors from withdrawing money and forcing managers to pay dividends from money invested by fellow REITs members. It’s also done to ensure that the value of the REITs shares and the cash flow aren’t affected.

High Fees

Non-traded REITs have high upfront fees, often as high as 15%. So although you may have good returns, you’ll end up paying a hefty slice of your profits on each and every REIT investment.

There is a better way to buy real estate. Buy directly. Not only will you have access to the information you need to determine whether or not the property truly fits your individual investment goals (and not those of a group of people who may not have the same investment goals or risk level as you).

Spend some time learning about the local market and the property type, and run the numbers on a potential deal. If you’re unsure whether or not a particular property has potential, contact your broker, who will help you find a property that produces a steady profit while you maintain 100% control of your investment.

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