Nontraded REITs: What Are They, And Should You Invest?

Real estate investment trusts (REITs) have long been a staple for investors seeking exposure to the real estate market without the challenges of direct property ownership. As REITs are required to distribute at least 90% of their earnings to shareholders, they have been coveted by passive investors who desire a steady income stream. 

However, income generated from REITs is taxable to shareholders at their respective taxation levels. In addition, REITs also pass along capital gains or losses to shareholders, which are subject to capital gains tax rates. 

Nontraded REITs: A Better Alternative? 

A nontraded REIT, also known as a nonpublicly traded REIT, is a real estate investment trust that is not listed on a stock exchange. Unlike their publicly traded counterparts, these REITs are not subject to daily market fluctuations, as they are not traded on stock exchanges. 

Nontraded REITs have emerged as an intriguing option for investors seeking diversification and stable returns. These REITs offer substantial tax advantages, making them an attractive option for investors seeking to generate passive income without elevating their overall tax burden. 

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A portion of a nontraded REIT’s monthly distribution can be categorized as the return of capital, offering a potential tax deferral ranging from 60% to 90%. The Tax Cuts and Jobs Act has catalyzed a reduction of 20% in the individual tax rate applicable to the ordinary income portion of a nontraded REIT’s distribution. Regulations typically facilitate the deferral of taxes on the return of capital distributions until the eventual sale of REIT shares. 

Blackstone Real Estate Investment Trust Inc. (BREIT) is one of the most popular nontraded REITs in the market, with an annual inception-to-date return of 10.6% as of Dec. 31. BREIT's transaction price per share stood at $14.10 as of Feb 1. The nontraded REIT has an annualized distribution rate of 4.6%.

Nonlisted Starwood Real Estate Investment Trust (SREIT), currently trading at $22.90, has an inception-to-date return of 8.2%. The fund has an annualized distribution rate of 5.2%. 

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Comparison With Publicly Traded REITs

Publicly traded REITs are often preferred to non-listed REITs as the former tends to be more liquid. Publicly traded REITs are listed on stock exchanges, allowing investors to buy or sell their shares easily during market hours, offering a higher level of price transparency. 

AvalonBay Communities Inc. AVB, one of the most popular equity REITs trading in the U.S., has an annual dividend yield of 3.82%. The REIT's four-year average dividend yield stands at 3.4%.  

Share prices of such publicly traded REITs are subject to market fluctuations, while their dividend payouts are subject to income taxes at investors' marginal tax rates. 

Conclusion

Nontraded REITs represent a distinctive investment option for those looking to diversify their portfolios with exposure to the real estate market. While they can have significant costs, several crowdfunding platforms are democratizing such nontraded REIT investments with lower minimum investment requirements and management fees. 

For instance, Arrived Homes' Arrived Single Family Residential Fund allows investors to gain an equity stake in single-family residential and vacation rental properties for as low as $100. The fund has a flat quarterly asset management fee of 0.25%. 

While these investments can offer attractive income streams and potential capital appreciation, the unique characteristics of nontraded REITs require a strategic and informed approach to mitigate risks and optimize returns in the long run.

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