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What is your opinion of investing in publicly traded REITs vs. private REITs?

Public and private real estate investment trusts are similar in that both own properties such as retail centres, offices, apartments and industrial buildings. Beyond that, however, there are key differences that investors need to know before taking the plunge.

Public REITs trade on a stock exchange and are highly liquid. You can buy or sell them at any time – and in any quantity – at a price determined by the market. Public REITs are also subject to rigorous disclosure requirements, which includes the filing of quarterly financial statements that offer a detailed look into the REIT’s earnings, cash flow and balance sheet. Adding another layer of scrutiny, most publicly traded REITs are followed by brokerage analysts who issue regular reports that keep investors abreast of important developments.

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Private REITs, on the other hand, are less liquid and generally not as transparent. Units are typically available to “accredited” or “eligible” investors who may need to meet certain income or asset tests, and there is usually a minimum initial investment of, for example, $10,000, $25,000 or $50,000 (assuming the REIT is open to new investors, which isn’t always the case). Once units are purchased, there is usually a required holding period – typically several months – before units can be redeemed. What’s more, redemptions usually occur on set dates and with a required notice period, so if you need your money right away, you may be out of luck. Another key difference is that private REIT unit prices are determined by quarterly or annual property appraisals, rather than by daily market forces.

So why would anyone buy a private REIT when there are dozens of publicly listed REITs covering virtually every real estate class, from strip malls and seniors residences to offices and apartments? Proponents of private REITs argue that they offer investors refuge from the daily gyrations of the stock market, where fear and greed may cause REIT unit prices to fluctuate more than the value of the underlying real estate portfolio. In theory, at least, the inability to sell easily might also be a benefit if it prevents investors from acting rashly during a market rout. Another advantage of private REITs is that they don’t face the costs that come with a public listing.

But it’s important to understand that, even though their unit prices don’t change on a minute-by-minute basis, private REITs are just as exposed to the risks of owning real estate as their more liquid, publicly traded cousins whose units are valued in real time by investors.

“The longer-term fundamental exposure and returns are likely to be very similar whether you hold real estate in a public or private vehicle,” says Dan Hallett, vice-president and principal with HighView Financial Group. “The trade-off for avoiding the daily stock market noise [with private REITs] is the inability to buy or sell at any time. This requires patience.”

Mr. Hallett says it’s critical to do thorough due diligence with any private investment, real estate or otherwise. Red flags can include a complex structure, high sales fees or conflicts of interest such as transactions between related parties. Promoters will highlight all of the investment’s positive characteristics, but Mr. Hallett says he has always found at least one negative characteristic when reviewing private investments. (Read more about Mr. Hallett’s views on private investments here.)

If you’re considering a private REIT, here are some questions to ask: Are the REIT’s financial statements readily available? Does the REIT have a well established operating history, or has it been in existence for just a few years? Has the distribution been stable (or, better yet, risen), or has the REIT had to cut its payout? Also find out whether there is a publicly traded REIT that invests in similar assets. If you can get access to the same types of real estate, with better transparency and liquidity, a publicly traded REIT may be a better choice.

Finally, if you’re not comfortable evaluating individual REITs, consider investing in an exchange-traded fund that provides broad exposure to the REIT sector, such as the iShares S&P/TSX Capped REIT Index ETF (XRE), the BMO Equal Weight REITs Index ETF (ZRE) or the Vanguard FTSE Canadian Capped REIT Index ETF (VRE). These ETFs have relatively low costs, provide excellent diversification by geography and property type, and pay solid monthly distributions. And you can buy or sell them at any time, with no minimums. However, I suggest you resist the urge to trade so you can enjoy the long-term benefits of holding real estate.

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E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to every e-mail but I choose certain questions to answer in my column.

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