Other Voices

The evolving nonlisted-REIT industry

Jan 13, 2013 @ 12:01 am

By Bob Aisner

Heightened investment in nonlisted REITs has continued due to investor demands for income and for opportunities to diversify portfolios with allocations to assets that go beyond traditional stocks, bonds and cash.

This growth has remained resilient in spite of occasionally disappointing estimated valuations. Although the recession served to increase the momentum for product improvements, it's indisputable that while these alternatives to equity real estate investment trusts continue to strike a chord with some investors, in other cases, they are hitting a nerve.

The appeal of public nonlisted REITs is evidenced by the $81 billion in equity raised by these programs since 1990. Equity raised by direct-placement programs, including nonlisted REITs and business development companies, exceeded $11 billion in 2011, representing an increase of 16% from 2010 and an increase of 47% from 2009. Equity raised by nonlisted REITs during the first eight months of 2012 was approximately 10% higher than the rate for the comparable period in 2011.

Even those who criticize nonlisted REITs would be wise not to ignore or overlook them. The appeal of nonlisted REITs has continued because they provide an important alternative to traditional stock and bond investing.


Although legacy nonlisted REITs that were investing in 2005-07, at or near the peak in property values, have taken their lumps, so have the financial markets. Nonlisted REITs, which in essence are closed-end funds, were not able to re-equitize after the recession as their traded brethren were doing, and thus they have been slower to recover.

Many investors are seeking safety from market volatility and uncertainty, and relief from low yields on fixed-income investments. Some investors are shifting partially from financial assets to hard assets, tactically retreating until the financial markets stabilize.

Although these conditions are fueling continued interest in nonlisted REITs, there also is significant demand for the next generation of nonlisted-REIT products that are more reliably aligned with defined investment objectives. Based on the experience of the past few years, investors are asking for such enhancements as greater liquidity, more valuation transparency, more-timely estimated valuations and lower fees.

Equity REITs have matured during a 52-year history of operations. In contrast, the 22-year history of the nonlisted-REIT industry makes it comparatively immature. Much of the growth in the industry occurred after 2000, and the capital raised by these programs did not reach a pre-recession peak until 2007. As the industry continues to mature, we have a critical opportunity to address these challenges with meaningful product innovations, improved education and new business models.


Although this evolutionary process will be important to the future of the nonlisted-REIT industry, it certainly won't be a journey unique to it. Every segment of the financial products industry must evolve and adapt to investor demand. More-mature product types simply have a longer history of successful evolution.

The nonlisted-REIT industry has no quarrel with its traded counterparts. Each REIT product type plays an important and necessary role for suitable investors, and there is plenty of room in the marketplace for both.

But make no mistake — public nonlisted REITs are designed for informed investors who understand the diversification role of alternative investments in asset allocation. Even with emerging product enhancements, nonlisted-REITs will still involve illiquid, long-term investments that are unsuitable for investors who require short-term liquidity.

Although nonlisted REITs have the potential to provide current yield, they are not a fixed-income alternative. Even for suitable investors, nonlisted REITs should be added to an individual's investment portfolio in an amount appropriate to a diversified asset allocation. As with any investment, an inappropriate allocation or concentration will magnify the impact and results, both on the upside and the downside.

All industry participants stand to benefit from a deeper understanding of the potential risks and rewards of investing. The most time-proven technique for accumulating wealth, and for subsequently providing distribution income for retirement, still involves investments that reflect clear strategic goals and a well-ordered asset allocation plan that achieves broad diversification consistent with the investor's risk tolerance.

Liquidity is an important component of many investments, but it comes at the price of market volatility. Because direct real estate investments are not correlated to the same forces as those that affect the equity markets, they can effectively reduce a portfolio's exposure to market volatility.

However, like other asset classes, real estate markets are unavoidably cyclical, and therefore subject to separate, noncorrelated volatility and pricing cycles that can't be predicted reliably. There will always be a lagged relationship between the demand for physical space and its available supply. Demand must be reliably demonstrated to encourage new construction, and this creates a lag. In addition, real estate prices exhibit a lagged response to macroeconomic changes. These factors form the basis of the real estate cycle.

When supply is constrained, real estate values usually rise. But values often fall when new supply is added too quickly or employment softens. Change is the only constant in real estate markets, and peaks and troughs in property values can be accurately identified only with hindsight. Although sound program management is important, no one can time the market, and market cyclicality will always influence returns.

In addition to improving our products, we must continue to focus on educating financial advisers and investors about the real estate cycle and other macroeconomic factors that affect the performance of nonlisted REITs.


Disappointing performance in the aftermath of the economic and credit crisis of 2007-09 has increased regulatory scrutiny of public nonlisted REITs as well as many other investment vehicles. The resulting actions by the Financial Industry Regulatory Authority Inc. and the Securities and Exchange Commission, which are often a response to investor concerns, have a far-reaching impact on the entire industry.

Finra and the SEC are using their influence to increase transparency and promote disclosure standardization by mandating the timing of post-offering estimated share valuations, establishing requirements that affect the share values appearing on account statements and requiring enhanced disclosure surrounding estimated valuations, among other regulatory efforts. These changes can require nonlisted REITs to retool and revise their processes. But when managed well, responses to regulatory action can increase standardization among products, and improved standardization will enhance the general attractiveness of nonlisted REIT products.


Economic downturns often prompt investors to demand that investment programs perform more efficiently. This demand is prompting the nonlisted-REIT industry to rise to the challenge by improving products and business models, driving more-rapid evolution.

During the post-recession recovery, some sponsors have introduced direct-placement programs that provide more-frequent estimated valuations and enhanced share redemption features. Many are closely watching how well these products are accepted in the marketplace and whether they function as planned.

New approaches that enjoy market acceptance and successfully meet their objectives could dramatically alter the future of this nascent industry. Although these changes will not make nonlisted REITs suitable for everyone, they will influence, and possibly accelerate, the evolution of the product.

The nonlisted-REIT industry has entered a period of rapid transition as it strives to create innovative products and help financial advisers and investors understand better how these products can appropriately address post-recession investment challenges.

Although such fundamental change can be difficult and even painful, I believe that program sponsors should embrace these challenges rather than retreat from them. The future growth and success of the public nonlisted-REIT industry can be assured as program sponsors recognize and respond to this historic opportunity.

Bob Aisner is chief executive and president of Behringer Harvard Holdings LLC, the parent company of several nonlisted REITs.


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