And here we go, back to reliving the past and picking at those long forgotten financial wounds for my second post on financial mistakes, the dastardly private REITs…
Preface – I’m not going to go into all the details on different kinds and tax treatment of REITs here. If you don’t know what one is, click this for a summary article. The main points that you need to know are that REITs are usually companies that own and operate real estate and typically have to payout a minimum of 90% percent of their taxable income in the form of dividends each year (hence, investors love the typically higher cashflow yield). Most REITS are publicly traded on exchanges and bought and sold like stocks. Private REITs are not registered with the SEC and don’t trade on national securities exchanges. They work solely as private investments selling to a select list of investors.
If someone is trying to sell you a private REIT, run the other way.
If you recall in my first post on financial mistakes about load mutual funds, I had summarized that I was young and recently out of college, wanted to start investing my savings and had just picked a financial planner to invest with (the only one I knew that my parents were using).
The first thing the advisor set me up with was a Roth IRA and front-end load mutual funds. The second investment vehicle he selected for me was to buy into a private REIT with a $10K minimum.
When I look back at this, I still get a little mad. It’s water under the bridge, but here I was, an excited, youthful kid who was genuinely interested in trying to improve his future and learn about investing, and this CFP must have seen S-U-C-K-A tattooed across my forehead. I bet he was just drooling at the mouth when I told him I have $20K to invest and have no idea what to do with it.
Can you help me please?
And help me he did. He helped me waste some hard-earned cash so that he could line his pockets.
His pitch was like any other charlatan:
This is for a limited time only, you’ll get higher dividends than publicly traded REITs, less regulation fees so more money in your pocket. Then once these properties appreciate and we charge higher rents, we’ll go public and you can cash out like a king… and on and on and on.
I couldn’t lose, right? A no brainer. I could picture the future returns lining my pockets and becoming the building blocks that I would construct my retirement portfolio upon. Laying down those bricks of compound interest one percent at a time. I would live like royalty in my golden years.
Well, let’s see what happened…
For the first year or two things were fine. I received a paper statement each quarter that showed my dividend and the additional shares it was buying.
Then the financial crisis hit. The REIT burned through cash like wild fire and had to go public even though the price would be disastrous for early investors (like me).
My $10K became $1K overnight. Ouch! Ninety percent of my investment up in smoke not to mention the lost investment time.
It compounded all right. Compounded in the wrong direction like a boss!
This was an expensive lesson to learn, and learn I did. Losing money can prove to be quite the motivator to increase your investment knowledge and protect yourself from being taken advantage of in the future.
I was lucky in that my REIT actually went public. I was able to eventually sell the $1K and lock in the $9K loss to write off on my taxes. But most people aren’t that lucky. High commissions can erode shareholder value or the lack of transparency can lead to investments in bad markets or dividend cuts that leave shareholders with worthless shares that they can’t even sell. At least for me there was a small silver lining to this disaster that I could utilize.
There are a couple of things I want to point out on private REITs for those still not convinced this is something you want to treat like a deadly disease just waiting to infect you and steal your money.
Private REITs are SOLD not bought.
First, I can’t stress this enough: private REITs are sold not bought. That should be your first question when someone is trying to sell you this: If this is such a good investment, why can’t everyone buy it? No investment is just sitting there waiting to make you money. If it is a good idea then it will be available to the masses.
Second, because of the increased risks with private REITs, they are supposed to be sold to accredited investor’s only. Accredited investors are usually institutions or people with over $1M in net worth or who make an income of at least $200K annually. How I, as a young kid with only $25-30K in net assets and probably around $30K annual income was sold this product still ticks me off.
Third, lack of transparency should be a deal killer. If you can’t see the fine print, then you don’t know what conflicts of interest might be happening. Remember Bernie Madoff? If something sounds too good to be true, it usually is. Don’t chase exceptional returns when there is a proven track record for good profits. Avarice can be a killer in this industry.
Fourth, understand the commissions you will be charged. It is imperative that you dissect how the seller/broker is being paid. This will reveal a lot as far as motivation if you can connect the dots behind the scene. Plus, higher minimum investments also mean larger commissions for that broker.
Fifth, do your research. Being young like I was is not an excuse. I decided to trust someone else instead of digging in and doing my own dirty work. I say this often but it is worth driving home the main point: no one will manage your money better than yourself! Take the time to educate yourself.
In the end, Caveat Emptor.
Hopefully if you read this post, then you will not make the same mistake that I made and end up doing a little more investigating before you pull the trigger on your next investment.
So how about yourself? Has anyone else had any horror stories from purchasing a private REIT?
Tell me all about it in the comment section below.
-Q-FI
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