We have noted in our research and our posts that non-traded investments including non-traded real estate investment trusts (REITs), business development companies (BDCs), oil & gas and equipment leasing partnerships typically have extremely high upfront and ongoing fees. Because of these high costs, illiquidity, lack of transparency and conflicts of interest, these investments should underperform liquid, lower-cost traded investments with similar underlying exposures. For example, non-traded REITs should underperform liquid, low-cost traded REITs. Essentially, since non-traded REITs are in the same market for real estate that mutual funds, exchange-traded funds, and other real estate investments invest in, non-traded REITs can’t on average make up in returns what they take out in fees.
BlueVault Partners, LLC is an investment research firm focused on non-traded REITs and business development companies (BDCs). In September 2012, BlueVault and the University of Texas at Austin's Real Estate Finance and Investment Center issued a report that looks at the returns on a sample of 17 non-traded REITs. They then updated their study in November 2013 to cover 10 more non-traded REITs. While the 2013 study is not publicly available, a summary of their findings is available here.
On the surface, both the 2012 and 2013 versions of their study support our interpretation. The 2012 study notes:
Adding back a plausible estimate of fees leads to estimates of unloaded return that suggest that nontraded REITs perform fairly similarly to their [traded REIT] benchmarks in terms of their real estate portfolios’ returns.Likewise, from the 2013 study's summary:
Removing the effects of a hypothetical 12% front-end load for all nontraded REITs in the sample, the average nontraded REIT achieved comparable returns to the FTSE NAREIT publicly traded benchmark returns.Adding back in the 12% upfront fees, investors in the non-traded REITs covered by the Blue Vault study did about as well as traded REITs. More clearly, investors in the BlueVault REITs had holding period returns which were 12% lower than holding period returns in traded REITs.
However, the truth about non-traded REITs is likely even worse because the BlueVault study only considers the few REITs that had "provided shareholders with full liquidity" through a merger, liquidation, or public listing. These are likely to have been the best performing non-traded REITs; excluded were many of the non-traded REITs that have suffered huge dollar value losses -- for examples, Inland American, Behringer Harvard REIT I (a/k/a TIER REIT), and CNL Lifestyle Properties (a/k/a CNL Income Properties) were not included. Including only the 'full-cycle' non-traded REITs creates a conspicuous selection bias that overstates the returns to non-traded REITs as a whole.
The BlueVault study is analogous to comparing the returns to venture capital investment in social media companies to returns in the stock market but only considering the experience of venture capital investors in Facebook, Twitter and LinkedIn. Even with this selection bias, the Blue Vault study had to add 12% to the returns earned by investors in the non-traded REITs it covered to get them to equal the returns earned by investors in traded REITs over the same time periods.
By choosing only so-called 'full cycle' non-traded REITs, the BlueVault study presents a biased look at the market for non-traded REITs. By our estimates, BlueVault's sample reflects only about half of the capital raised by the over 100 non-traded REITs in the United States, and does not fully reflect what many non-traded REIT investors have experienced.
In upcoming posts, we will report on our analysis of returns earned by investors in almost all non-traded REITs, not just the winners included in the industry’s study.