We take a close look at a private REIT to show the importance of looking beyond marketing hype
One key aspect of a marketer’s job is to describe the features of whatever he’s selling as a benefit to the potential buyer. Understanding this process can help you get past the marketing and get better value when you make consumer purchases. It can be an even bigger help in keeping you out of bad investments.
We’ll use the example of a private REIT (real estate investment trust) that one of our Inner Circle members asked about. This particular private REIT yields 9%. That’s a super yield at a time of today’s low interest rates. But a high yield is always a sign that you need to look for hidden risks. We looked and there they were, dressed up as investor benefits.
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This private REIT specializes in small-town real estate. Promotional material for the REIT portrayed this investing strategy as a benefit to investors. It explained that small-town real estate investments produce above-average returns due to four factors: low supply, high building costs, sustained high demand and low vacancies.
Any or all of these factors can be present in the real estate of a particular market at a particular time. However, things change.
For instance, small towns often depend on at most a handful of employers. If one of the town’s main employers reduces its operations or shuts down, tenants leave town. As populations shrink, the town’s rental accommodation vacancy rate can go up and stay high indefinitely.
This problem is even more pronounced in a small town’s commercial real estate. Offices, storefronts and industrial space are more specialized than residential real estate, due to factors such as zoning, ceiling heights, pedestrian traffic, parking and so on. If apartments stay vacant for months, commercial space can stay vacant for years.
Even at the best of times, small-town real estate is harder and more expensive to finance than city properties. Because of the higher risk of cut-offs in rental income, lenders demand bigger down payments and higher mortgage rates. This makes small-town property harder and more expensive to sell.
Small-town real estate has to provide high returns in good times to offset the higher risk of loss when the market turns downward.
This particular REIT is private, unlike conventional REITs, which are publicly traded. That means this REIT calculates the value of its own units (just once a year in this case), and needn’t reveal all the information that’s available to the public from publicly traded investments. It portrays this feature as a benefit—since it avoids the volatility and speculation of public markets!
On the other hand, staying private also cuts the likelihood that nosy outsiders and analysts will find out about and draw attention to hidden risks and problems that the REIT happens to suffer from.
The combination of these two “benefits”—a small-town focus plus a once-a-year valuation by the REIT’s insiders—would be enough to make us advise against investing.
Investing tip: Use our three-part strategy
No matter how you invest for retirement, you should take care to spread your money out across the five main economic sectors: Finance, Utilities, Consumer, Resources & Commodities, and Manufacturing & Industry.
By diversifying across most if not all of the five sectors, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or investor fashion.
You also increase your chances of stumbling upon a market superstar—a stock that does two to three or more times better than the market average.
Our three-part Successful Investor strategy:
Invest mainly in well-established companies;
Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities);
Downplay or avoid stocks in the broker/media limelight.
Have you ever invested in a financial product like a private REIT that turned into a bad investment? Share your experience with us in the comments.
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