Real estate-based securities
What are real estate-based securities?
There are two basic types of real estate-based securities.
One type is real estate investment trusts (REITs)
. These are public companies holding a diversified portfolio of real estate assets, which trade on an exchange. This page does not discuss these types of publicly-traded real estate-based securities.
Other real estate-based investments carry higher risk and are sold in the exempt market. These may include:
- an interest with others in a real estate property (syndicated real estate)
- an interest with others in a single mortgage (syndicated mortgage)
- an interest in a pool of properties
- an interest in a pool of mortgages, such as a mortgage investment company (MIC)
These exempt real estate-based securities are sold to investors without a prospectus and without the advice of a registered dealer. Some are sold under an offering memorandum (OM). The OM is a document that provides information about the company and the investment. It’s important to understand that securities regulators do not review OMs before the securities are offered to investors.
Real estate-based securities are valued on the basis of their underlying assets (one or more mortages, properties, etc) and anticipated cash flows. When mortgages are the underlying assets, the value is based on the quality of the pool of mortgages and the cash flows generated by the mortgages, not on the usual real estate fundamentals of location, price, and current market conditions.
What risks do they have?
When real estate is sold on an exempt basis, the risks are similar to those related to private companies and private company investing as well as the risks relating to the real estate itself.
There are several types of real estate risks
- Non payment risk. Whether you are investing in an interest in a single mortage, a pool of mortgages, an interest in a rental property or a pool of rental properties, there is a risk that the mortgage payments or rental payments will not be paid. Non-payment of rents or mortgage payments will have a negative impact on your expected returns.
- Property value risk. Whether you are investing in mortgages or property, a drop in property value affects your investment. If mortgage payments are not being made, the mortgage holder can sell the property. If the value of the property has dropped signficantly, the property will be worth less than the amount owing on the mortgage. For example, if you had invested in vacation property in the Southern US that looked good before the 2008 housing crash, you may have lost most, if not all, of your investment after the crash.
- Unrealistic projection risk. Sometimes the potential returns described by the promoters of these investments are based on historical or projected returns, not current real estate market conditions. For example, some promoters of undeveloped land will provide projections based on the expected property value once the property is developed and a manager is collecting rents and distributing them to investors. You need to focus carefully on the projections and ask questions to determine when, and if, they might become reality.
Can you sell easily?
No. Many syndicated mortgages, real estate syndications, and mortgage investment companies prohibit resales and virtually all prohibit redemption before the end of the term. The term on many real estate and mortgage invesments can be 5, 10, or 20 years.
In addition, exempt real estate-based securities are not listed on any stock exchange and almost all have resale restrictions, similar to private companies.
What are the costs?
Administrative costs or management fees, which should be disclosed in the purchase agreement, and legal costs may reduce your returns.
What are the expected type of returns?
If the real estate investment is based on mortgages or rental properties, you can expect to receive payments, similar to dividends, as long as the mortgage payments or rents are actually paid.
You can also expect to receive capital gains or capital losses, when the property is sold or when you sell your investment.
For more see these Investor Watches: Investing in real estate and Get the facts before investing in real estate-based securities.