Limitations of REITs
Everything that offers advantages comes with limitations, and so do REITs. Some of such limitations associated with REITs are:
1. Dividend Fluctuations: The dividend distributed by REITs is highly uncertain based on the fact that the amount of the dividend depends on the performance and income of the REITs. However, unlike publicly traded REITs that prioritize distributions from operational income, non-traded REITs may utilize offering proceeds and even borrowings to fund those payouts. This practice diminishes the value of your shares and limits the company’s ability to reinvest in new properties, potentially hindering future growth. A report by JLL (Jones Lang LaSalle) highlights that dividends can vary depending on factors like occupancy rates and rental income of the underlying properties.
2. Transparency: Valuing your non-traded REIT shares can pose a challenge. Unlike publicly traded REITs, which have accessible market prices, non traded REITs typically delay sharing value estimates until, at least 18 months after their offering closes. This lack of transparency makes it hard to measure how your investment is performing or its potential volatility, over a period.
3. Fees and Expenses: Non-traded REITs typically have higher upfront fees and ongoing expenses compared to publicly traded options. Scrutinize the fee structure before investing.
4. Interest Rate Sensitivity: Whenever interest rates rise, the cost of borrowing for REITs increases, which can lower their profitability and stock prices. REITs are highly sensitive to interest rates.
5. Limited Control: REIT shares are managed by professional managers, so the investors have very little control over the management and operation of the underlying real estate properties.
6. Market Risk: Like any other investment, REITs are subject to market risk. Any market downfall can adversely affect the prices of REITs shares and the value of the real estate.
7. Taxation: Although REITs are tax-efficient structures, the income generated is taxable as regular income.