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Should I invest in REITs?

Nov 26, 2015 8:00:00 AM
Author: Scott Hanson

Listen to Scott and Pat explain to a caller the disadvantages and advantages of REITs and Non-traded REITS. Should you invest in these alternative investments.

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Read Full Audio Transcript:

Scott Hanson: We're talking with Bob in Sacramento. Bob, you're with Hanson McClain.

Bob: Hey, guys. I appreciate your show.

Scott Hanson: Thank you, sir.

Bob: I wonder if you'd say a few words about REITs, the pros, the cons, the advantages, the disadvantages, what they are, and is this a good time to be investing in a vehicle like that?

Pat McClain: Perfect. Thank you for the question.

Scott Hanson: So we're going to back up a little on this, too. So a REIT is a real estate investment trust, and a REIT is a special type of corporation that has some unique tax advantages that other corporations do not have. And essentially the tax advantage that most companies deal with they have to pay their own income taxes, and then when they pay a dividend to the shareholders, the shareholders have to include that taxable income, so it's double taxation. With REITs, as long as a real estate investment trust has the majority of their investments in real estate or real estate type investments, and they pass through, I believe it's either 90% or 95% of their earnings to their shareholders, the income is not taxed to the company. It's only taxed to the shareholders. So it does not have the double taxation. So it's a great...from a corporate structure, when you look at C Corp, S Corp, LLC, REIT, REIT can be a very attractive structure for--

Pat McClain: From a tax standpoint.

Scott Hanson: From a tax standpoint.

Pat McClain: And remember there are two types of REITs, too. There's traded REITs, which you can buy on a stock exchange just like a ... you could buy Apple or Amazon or Chevron stock. And there's non-traded which are typically sold through brokers. And there's a huge difference between the two.

Scott Hanson: Yeah. And so a REIT, for example, Bob, if you say, "Well, I would like to own some apartment buildings. I certainly don't want to have the direct ownership myself nor do I have the capital," you can go out and buy a REIT that might specialize in apartments or a REIT that specializes in a variety of different things — shopping malls or whatever. So you can go out and invest in these, and you can go buy just on the stock exchange, or you can buy a mutual fund that invests in a variety of different things to have diversification.

Pat McClain: Which we actually are not opposed to at all.

Scott Hanson: No, and we've used periodically. We've used a lot over the years and ETFs which are indexes, essentially of the REITs. And so they can be a great piece of one's portfolio. The concern we have and the danger with these is that, what Pat mentioned, there's a type of REIT that are sold through brokers that are illiquid.

Pat McClain: They're non-traded which means you buy it, you own it. You don't know what it's worth. They're going to send you a statement where they guess what it's worth, but because it's not traded on an exchange, you have no idea what it's worth because there's no counterparty offering to buy it.

Scott Hanson: Not only that; if you can't really sell it. It's a limited partnership. You become a partner as a limited partner.

Pat McClain: So there are two things wrong. One, you bought it. It's got high commissions which comes right out of your pocket. So they typically sell for $10 a share. The cost of distribution is about $1 of that. So even though it doesn't reflect its real price, the day you buy it, the value has already been reduced by about 10%, and they're not required to reflect the real price for 18 months after they quit issuing it. It's funky.

Scott Hanson: You hear them pitched by brokers because they pay high commissions. They could pay commissions of 7%, 8%, even higher to a broker who sells these.

Pat McClain: So REITs are not bad. Non-traded REITs are terrible.

Scott Hanson: We don't see the benefit of them.

Pat McClain: Because the alternative is right there. The difference is you buy a non-traded REIT, here's the benefit; you get to deal with a broker that is cramming this garbage down your throat. You buy a traded REIT; you don't have to.

Scott Hanson: Yeah. Does that help?

Bob: Yes, sir. It does.

Pat McClain: And remember, when you're buying yield on these things, that yield is not guaranteed, right?

Bob: Right.

Pat McClain: So we see what they're now calling it is either liquid alts or alts or alternatives, and the reason they're attractive right now is people are actually searching for yield. That yield is not guaranteed. And it is subject to market forces just like anything else.

Bob: Right. A friend of mine did pretty well on them years and years ago, but I had no idea where they stood today. Appreciate your program.