Private REITs and other securities are often touted as having many benefits over those that are publicly traded. These benefits include higher dividends paid on a monthly basis and having less market risk than their publicly traded counterparts. One mammoth private REIT, Inland Western Real Estate Trust, offers us a case study into these claims.
The Story of Inland Western Real Estate Trust
Inland Western Real Estate Trust, Inc. filed its offering with the SEC on September 15, 2003. According to their web site, this is a self-administered, publicly registered, non-listed real estate investment trust. Inland Western is focused on the acquisition, development and management of retail properties.
Inland wasn't a newcomer to the Private REIT Market. Inland spokesperson, Matt Tramel, told me of two past successful liquidity events with Inland Real Estate Corp (IRC) going public in 2004 at a price of $11.70, and a prior trust being sold for $14.00 a share to another public REIT. Both trusts had a $10.00 initial offering price, paid dividends, and had liquidity events higher than this offering price.
Of the $10.00 initial offering price for this REIT, the filing shows that $1.05 went to commissions, and that there were other expenses on top of this 10.5%. Thus, not all of the investors' money went toward buying real estate. Tramel stated these fees were in line with publicly traded REITs, and that dividend reinvestments avoided these fees.
Dividends and a liquidity event seemed in the cards for this latest Inland REIT as well. The company issued nearly $4.6 billion in stock as investors bought in. The REIT paid handsome dividends until the end of 2008, when the real estate bubble collapsed.
This isn't one of those disaster stories. Today, Inland still pays a small dividend, though now on a quarterly basis. The company says it has made great strides restructuring its debt and, according to its ERISA valuation, the stock is still worth $6.85 per share as of December 31, 2009. The company notes it has paid out $3.55 per share in dividends, which implies a slightly positive overall return, since the share price plus the dividends totals $10.40 per share. This gives roughly a four percent total return.
Death, divorce, or distress in the secondary market
Unfortunately, the $6.85 per share ERISA valuation doesn't translate to what you could actually sell it for, since there are no public markets. Inland provided a list of eight companies facilitating trades of their stock. I spoke to Neal Buckley, sales manager of American Partnership Board, about how his company facilitates these trades.
Buckley described his company as a "matching service," putting together buyers and sellers in an auction that seems very much like eBay. Commissions range from three to 7.5 percent, though they can be higher with amounts less than $4,000. I was actually surprised by the commission fees in that they are lower than the 10.5 percent when the Inland issued the shares.
In this secondary market, however, market price is nowhere near the ERISA price of $6.85. Buckley noted that Inland shares traded between $4.00 and $5.10 per share so far this year. He stated that nearly all those listing their shares for sale were for one of three reasons:
- Death - the shares were inherited and the beneficiary wants cash.
- Divorce - the spouse ending up with the shares wants cash.
- Distress - the party can't wait for Inland's liquidity event.
Some cold hard facts.
Inland paints a pretty picture, but the facts don't seem as rosy.
- This Inland Trust has been an underperformer. Using the ERISA price of $6.85 gives a total estimated return of about four percent. Using an average trade on the secondary market of $4.55 yields a loss of about 19 percent, before commissions. During that same period of time, the Vanguard REIT index fund (VGSIX) gained about 65 percent. Simon Property Group (SPG), a retail REIT that happens to be the largest holding in the index fund, gained about 142 percent over the period.
- Commissions and costs of 10.5% do not compare favorably with publicly traded REITs. Once they are public, REITs can be bought for a total cost of $7 a trade plus a very small bid-ask spread.
- Private REITs are not less volatile than public REITs. Don't confuse the fact that you can't see a changing price several times a day with less volatility. In fact, you have the added risk of a liquidity event.
- Inland provided no data of its successful track record. While the two prior REITs had a gain upon their liquidity event, the company didn't compare the return to public REITs that skyrocketed over the period.
- Inland shareholders apparently cannot cash out without settling for a very large discount over the company's estimated price until the company has a liquidity event, which is far from guaranteed.
REITs are good diversifiers as they often don't move with the stock market as a whole. The last bubble is one exception since it was the real estate bubble that caused the crash. Buying a private REIT or other non-listed security, however, is filled with costs, risks, and lack of diversification.
Own your REITs through a low cost REIT index fund and you'll get low costs, diversification, and liquidity. REITs are risky enough without taking on any unnecessary risks. My only exception to this rule would be to take a little bit of a gamble and buy small amount of Inland on the secondary market, at a large discount. Someone's death, divorce, or distress may ultimately be your gain.
Author's note: On July 9, 2009, I entered into an oral agreement to purchase shares of Inland Western and a related private REIT, Inland American, on the secondary market. These shares were purchased at substantial discounts from the initial offering and are part of my gambling portfolio.