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November 23, 2013

Beware of non-traded REITS

In today’s low-interest rate environment, individuals -- especially retirees who depend upon their portfolio to help meet spending needs -- are turning to “alternative” investments in search of higher returns. One such investment is the non-listed real estate investment trust (REIT).

Individuals invest in real estate to improve the diversification of their portfolios and to own a share of assets such as land and buildings that have tangible value. For those who understand the risks of real estate ownership, these are valid reasons to make such an investment. Stretching for higher yield on a portfolio, however, is not.

A REIT is an operating company that pools the capital of many investors in exchange for ownership shares. The company then purchases and often manages a portfolio of properties such as shopping centers, office buildings and apartment complexes. REITs offer the average investor an opportunity to own property without the large investment and responsibility associated with buying and managing it directly.

With these benefits, however, comes additional risk. REITs are volatile investments that behave more like stocks than bonds. Anyone substituting REITs for bonds in their portfolio to generate higher income will have created a more aggressive, stock-heavy allocation.

There are three basic REIT classifications. First are private issues sold through exclusive offerings to investors who meet certain income and net worth criteria. Second are issues available to the public that trade on a national exchange. Third are issues available to the public that do not trade on those exchanges. It is this latter group, known as non-traded REITS, that has been most aggressively sold by Wall Street firms through commission-based sales reps. Sales of these products have surged over the last few years and are on pace to reach $17 billion in 2013, with much of them finding their way into the portfolios of retirees and other unsophisticated investors desperately seeking higher income.

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