Choosing Non-Traded and Private REITs For Your Self-Directed IRA

Real estate is a popular investment within self-directed IRAs. Investors love the tangible nature of land and property, the current income, potential for growth in rental income, and the potential for capital appreciation. There are also a number of tax advantages that apply to real estate that don’t accrue to other asset classes.

But not everyone wants to be a landlord. For those people, owning shares in a real estate investment trust (REIT) may be an option.

Often, people attracted to self-directed IRAs are also attracted to non-traded REITs… that is, real estate investment trusts that are not traded on the stock market and are not rated by investment analysts or widely followed.

About Non-traded REITs

Like exchange-traded REITs, non-traded REITs invest in real estate. They are also subject to the same IRS requirements that an exchange-traded REIT must meet, including distributing at least 90 percent of taxable income to shareholders. Like exchange-traded REITS, non-traded REITs are registered with the Securities and Exchange Commission and are required to make regular SEC disclosures, including filing a prospectus and quarterly (10-Q) and annual reports (10-K), all of which are publicly available through the SEC’s EDGAR database.

Private REITs

Not all REITs are subject to the SEC requirements above. There’s another category called ‘private REITs,’ which are exempt from the requirements listed above. These REITs may carry a higher yield, but they are also higher risk to investors. Generally, these are only available to accredited investors. They call for extra-thorough due diligence. But you can still own them with  a self-directed IRA.

The Liquidity Premium

Yes, shares in these companies can be difficult to sell, and you may have to pay a broker’s commission to unload shares for you. That’s true for direct real estate ownership in a self-directed IRA, as well.  But in the meantime, investors can enjoy a much greater income yield on the dollar. Why? Because liquidity and convenience come at a price. Investors tend to bid up prices on highly liquid publicly-traded REITs – which in turn forces down dividend yields.

If you’re really sharp about real estate, and you know how to do your own due diligence, and you want to maximize your income yield on the dollar, you might consider a privately-held, non-traded REIT for your self-directed IRA.

Before you invest, though, be sire to follow these tips for selecting the best REIT for your portfolio:

  1. Have a healthy appreciation for risk. It wasn’t that long ago that many REITs lost half their value as real estate values collapsed. Some cities like Miami, Las Vegas and Phoenix were particularly hard-hit. Geographic diversification matters – though some investors like making targeted bets on individual markets. If you choose a focused strategy rather than a diversified one, just be sure you have a reason for what you do, and it fits in your overall investment strategy.
  2. Have a long holding period. Because transaction costs with non-traded REITs are high (up to 15 percent), the best way to own a non-traded REIT is to plan on keeping it for many years. Think of it as a marriage, not a fling.
  3. Look closely at the dividend. Is it really from rental income? Or is part of it a return of capital? Return of capital is more tax-efficient, but it’s also kind of like eating your seedcorn. Besides – if you’re holding the REIT in a self-directed IRA, tax-efficiency is not a concern for you.
  4. Does the dividend exceed operating cash flow? If so, the REIT is eating itself alive trying to attract yield-chasing investors. They could be selling good properties or they could be paying dividends with borrowed money. Don’t get so hungry for yield that you don’t care where it comes from.
  5. How’s the balance sheet? High leverage can make a REIT shine for a while – in a good economy. But the more leveraged the balance sheet, the bigger the hit when markets turn on you.
  6. Is the REIT compliant with SEC filing requirements? If it’s behind or if its filings are incomplete, this is a very bad sign.
  7. What are the early redemption policies? Some REITs and private placements place restrictions on your ability to access your money for a number of years. Make sure your time horizon is longer than the lockout period!