Morningstar Advisor - February/March 2012 - (Page 66)

Gray Matters The Public REIT Sector, as a % of Its $1.2 Trillion Aggregate Enterprise Value The Basics Nonlisted REITs differ dramatically from their listed counterparts. Although nonlisted REITs are SEC-registered “public” entities, they do not trade on a major exchange and are therefore illiquid. Nonlisted REITs are also sold as “blind pool” investments, meaning that, unlike most listed REITs, they raise investment capital identifying and buying specific investments. Nonlisted REIT shares, or units, are sold by financial advisors and are typically available for $10 each throughout a “bestefforts” offering period, which often spans several years. 62% 24% 13% 1% nonlisted REIT segment. (Estimated enterprise value, or total capitalization, is $167 billion, which assumes 45% leverage on programs closed or within offering periods.) Nonlisted REITs were on pace to raise approximately $10 billion in 2011, the highest annual amount since 2007, when $10.9 billion was raised.2 The Drawbacks Listed Equity REITs Listed Mortgage REITs Nonlisted Equity REITs Nonlisted Mortgage REITs Data as of Dec. 31, 2011 (listed REITs); March 31, 2011 (nonlisted REITs) Nonlisted REIT Growth, Since 2000 2011 2000 On average, nearly 100% of a nonlisted REIT’s shares outstanding are marketed to and owned by individual retail investors, rather than institutions, who stick to listed REITs. Nonlisted REIT securities are typically distributed through a broker/dealer affiliated with the REIT sponsor. The affiliated broker/ dealer receives fees for marketing, distribution, investor relations, and maintaining SEC registration and reporting requirements. Significant Growth Nonlisted REITs present a number of problems for the retail investor, to whom most nonlisted REITs are sold. The financial crisis has drawn even more attention to these issues. Investors feel misled, and regulators have noticed. Efforts are under way to both improve the product and investor suitability and to better align shareholder interest. Before investing in nonlisted REITs, investors should consider these 10 potential areas of concern: 1. Costs and fees Costs and fees associated with an investment in nonlisted REITs average 15% to 18% of the initial investment (a net investment of $0.82 to $0.85 per $1). This compares with the $0.97 to $0.99 net investment in shares of listed REITs purchased in the secondary market. 2. Costly diversification Like most listed REITs, nonlisted REITs generally follow narrow portfolio and operating trategies, which allow managers to better capitalize on their sector or geographic expertise. So, diversification across commercial real estate property types is costly, as multiple nonlisted REITs mean multiple sets of high fees. 3. Blind-pool structure Blind-pool investments, such as nonlisted REITs, raise investment capital before buying and/or identifying investments. Because a nonlisted REIT’s offering and investment (or stabilization) period is a process that takes several years, investors may find it difficult to evaluate the merits of the investment. 4. Potential dividend risk The blind-pool investment structure and lengthy offering period means there may be limited Equity Market Capitalization Enterprise Value (estimate) Real Estate Assets Held Number of REITs Data as of March 31, 2011 $91.9B $172.4B $67.0B 73 $18.2B $52.0B $1.6B 5 Listed REITs are the largest segment of the REIT industry and have proved to improve the return and risk of a traditional long-term investment strategy. According to the FTSE NAREIT All REIT TR Index, listed REITs would have provided investors with an average annualized total return of 10.2% (and 10.9% for just equity REITs) over the past 20 years (ended Dec. 31, 2011), outpacing the S&P 500’s 7.8% increase. The index’s dividend growth has also impressed, averaging 5.8% annually since 1991 and exceeding the average annualized inflation of 2.6%.1 Further, listed REITs have generally outperformed other investment classes during slow economic growth and during periods of rising inflation and interest rates. Despite the long-term attractiveness and accessibility of listed REITs, yield-hungry investors have been clamoring for their less-liquid and less-shareholder-friendly nonlisted cousins in recent years. Although the nonlisted segment of the REIT industry has been around for some 30 years, its most significant growth has occurred over the past 10 years, with the catalysts being broader acceptance of the REIT structure, healthy commercial real estate fundamentals, and a need for greater investor asset-class diversification and yield. Nonlisted REITs, as of the first quarter of 2011, owned or had an investment interest in real estate assets valued at $67 billion, up 419% from $1.6 billion in 2000. Nonlisted REIT sponsors and programs currently number 31 and 73, as compared with four and five in 2000, respectively. Since 2000, nonlisted REITs have raised an aggregate $73.7 billion, representing 80.2% of the current $91.9 billion equity capitalization of the 66 Morningstar Advisor February/March 2012

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2012

Morningstar Advisor - February/March 2012
Contents
Contributors
Letter From the Editor
Make a Difference Stories, Not Debates
How Concerned Are You About Europe?
Analytical and Independent
What to Ask When a Fund Manager Leaves
Past, Present, Future
Have Financials Gotten Cheap Enough?
Four Picks for the Present
Investment Briefs
Tactical Funds Miss Their Chance
Specialty Retail: Ad Hoc Opportunity
How Europe Is Making Its Crisis Worse
Impact on U.S. Economy Will Be Minimal
European Banks: Bargains or Value Traps?
Don’t Count the Euro Out Yet
Europe on the Brink
GoodHaven Realizes Its Vision
How Index Trading Increases Market Vulnerability
Nonlisted REITS: Handle With Care
Safety Picks for the Many Moods of Mr. Market
On the Prowl for Large- Blend Index-Beaters
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The Math That Matters

Morningstar Advisor - February/March 2012