Understanding REIT Investments: What Investors Should Know Before Committing Capital

Real Estate Investment Trusts, or REITs, have become an increasingly popular vehicle for investors seeking exposure to the real estate market without directly purchasing property. Designed to pool investor capital to buy and manage income-generating real estate, REITs promise regular income and potential long-term appreciation. However, beneath this surface appeal lies a complex investment structure that carries unique costs, risks, and legal implications. Investors should approach REIT investments with careful scrutiny and understand not only how they work but also how regulatory bodies such as FINRA and the SEC have responded to related misconduct in the financial industry.

Types of REITs and Their Transparency Risks

REITs allow investors to collectively own shares in a diversified portfolio of real estate assets. These assets may include apartment complexes, office buildings, shopping centers, hospitals, or industrial warehouses. In return for their investment, shareholders typically receive a portion of the income generated by these properties, primarily through dividends or distributions. What distinguishes REITs from direct real estate ownership is that investors do not own the properties themselves but rather own equity in the trust that manages them.

While the concept appears straightforward, REITs come in different forms, each with varying degrees of transparency and liquidity. Publicly traded REITs are listed on major stock exchanges and can be bought and sold much like stocks or mutual funds, making them relatively liquid and easy to value. However, many retail investors are recommended non-traded REITs, which are registered with the SEC but not listed on public exchanges. These non-traded REITs pose significant challenges, especially concerning liquidity. Investors may find it extremely difficult to sell their shares before a predetermined liquidity event, which may not occur for several years, if at all. There are also private REITs, which are not registered with the SEC and are typically limited to institutional or accredited investors. These tend to offer even less transparency and investor protection.

The Hidden Costs of REITs and Why They Matter

One of the most critical yet often overlooked aspects of REIT investments is their cost structure. Particularly in the case of non-traded REITs, upfront fees can be substantial. These frequently include sales commissions, due diligence fees, and organization and offering costs, which together may consume up to 10% or more of an investor’s principal before any capital is even allocated to real estate. This means that for every $10,000 invested, only about $9,000 or less might be working for the investor from the outset. In addition to these upfront charges, REITs typically impose ongoing asset management and advisory fees that erode returns over time. Some also charge fees for reinvested dividends or impose penalties for early redemption, further diminishing potential gains.

The significance of these costs becomes apparent when considering their compounding effect on long-term investment performance. High upfront fees create an immediate drag on returns, forcing the investment to generate disproportionately higher returns just to break even. For example, a REIT must deliver returns well in excess of average market performance merely to overcome the initial reduction in principal. When ongoing management and operational fees are layered on top, the hurdle becomes even steeper. These recurring costs quietly chip away at income distributions and capital appreciation, which can significantly reduce the overall yield of the investment. In some cases, the high fee structure may incentivize sponsors to prioritize asset accumulation and fee generation over disciplined, risk-conscious real estate management, ultimately misaligning their interests with those of investors.

Moreover, these high costs and the fund’s underperformance can sometimes be masked, ironically, by and because many REITs pay regular distributions. Investors may be lulled into a false sense of security, unaware that those payments may not reflect actual investment gains but could instead be funded from offering proceeds or borrowings. This illusion of income, coupled with the difficulty of exiting the investment early, can lead to a dangerous complacency where investors do not fully appreciate the toll that high fees are taking on their long-term returns. For these reasons, it is essential that prospective investors fully understand the fee structure and carefully assess whether the potential returns justify the associated costs.

Liquidity and Valuation Concerns: What Investors Often Overlook

Beyond costs, there are significant risks inherent to REIT investments that every investor should weigh with great care. Chief among these is liquidity risk, especially with non-traded and private REITs. Unlike publicly traded REITs, which can be bought and sold on stock exchanges throughout the trading day, non-traded REITs do not offer a public market for resale. Investors are often locked into these products for extended periods, sometimes for seven to ten years or more, with limited or no opportunity to exit early. Redemption programs, if offered at all, are typically restricted, may involve substantial penalties, and often provide less than the full net asset value of the shares. For investors who may need access to their funds due to changing financial circumstances or unexpected life events, this illiquidity can be a serious and costly constraint.

Equally concerning is the issue of valuation transparency. Because non-traded REITs do not trade on public markets, there is no readily available market price for their shares. Instead, investors must rely on periodic, and sometimes infrequent, valuations provided by the sponsor or manager, valuations that may not reflect the actual market value of the underlying real estate or liabilities. This opacity can obscure the true performance of the investment and complicate efforts to monitor risk or compare performance to other investment options. In some cases, REITs have continued to issue optimistic valuations or pay steady distributions even when the underlying real estate portfolio was underperforming, leveraging offering proceeds or debt to maintain the appearance of financial health. Such practices not only distort an investor’s understanding of performance but may also delay recognition of deteriorating asset quality until it is too late to respond.

Broader Market and Sector Risks in REIT Portfolios

REITs are also subject to broader market and economic risks that can adversely affect their value and income generation. Rising interest rates, for example, can increase borrowing costs for REITs and reduce the relative attractiveness of their dividend yields compared to other fixed-income investments. Economic slowdowns can impact occupancy rates, rent collections, and property valuations, all of which can depress income and asset values. Unlike stocks or mutual funds that may be more diversified across industries or geographies, REITs may be concentrated in specific sectors (e.g., retail, healthcare, or commercial office space), amplifying sector-specific risks.

These multifaceted risks, when combined with high costs and illiquidity, can significantly impair the long-term value of REIT investments. What may appear on paper as a high-yielding, stable income stream can, in practice, deliver disappointing results, particularly when distributions are supported by financing mechanisms rather than genuine operational income. For these reasons, it is imperative that investors not only review marketing materials and prospectuses but also critically examine the full economic proposition of the REIT, including its fee structure, redemption policies, debt load, and historical performance.

Regulatory Oversight of REITs

Given the complexity and risk profile of REIT investments, and particularly non-traded REITs, it is no surprise that they have been the focus of regulatory scrutiny for years. The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) have both issued extensive guidance and brought enforcement actions against brokers and firms that misrepresented REIT products or recommended them inappropriately to retail investors.

One significant example of this regulatory focus is FINRA’s Regulatory Notice 13-18, which offers detailed guidance on how firms must communicate with the public regarding unlisted REITs and other real estate programs. This Notice highlights several common deficiencies FINRA observed in marketing and sales materials, including overly optimistic statements about distribution rates, failure to clearly disclose that distributions may consist of return of principal, and the omission of material risks. FINRA emphasized that all communications about real estate programs must be fair, balanced, and not misleading, and must prominently present both the potential benefits and risks.

For instance, if a communication references steady distributions, it must also explain whether those payments are made from investor capital or borrowings, along with the implications of such practices on the sustainability of income and overall investment returns. The Notice also warns firms against misleading claims about price stability, redemption features, and projected liquidity events. FINRA made clear that risk disclosures cannot be relegated to footnotes or separate documents such as prospectuses; rather, they must be presented clearly within the communication itself. This guidance reinforces the need for vigilance by both firms and investors in understanding the true nature of REIT offerings.

Currently, the central focus of enforcement actions in this space is often the question of whether the financial professional acted in the best interests of the investor, a standard that has taken on renewed significance since the SEC’s adoption of Regulation Best Interest (Reg BI) in 2020.

Reg BI imposes a more robust obligation on broker-dealers than the traditional “suitability” standard under FINRA Rule 2111. While the suitability rule required, among other things, that brokers have a reasonable basis to believe a recommendation was suitable for the customer based on their investment profile, Reg BI goes further. It mandates that a broker-dealer may not place its own financial or other interests ahead of the retail customer’s interest when making a recommendation of a securities transaction or investment strategy involving securities. This includes recommendations to invest in complex products like REITs.

Under Reg BI, broker-dealers must comply with four component obligations: the Disclosure Obligation, the Care Obligation, the Conflict of Interest Obligation, and the Compliance Obligation. These duties require brokers to disclose key facts about the investment, including risks, fees, and potential conflicts, and to exercise diligence, care, and skill in evaluating whether the investment is in the best interest of the investor. In the context of REITs, especially those that are non-traded or illiquid, these obligations are crucial. A broker recommending a high-cost, long-duration, and illiquid product to a risk-averse retiree without a thorough assessment and clear explanation of the risks would likely be acting in violation of Reg BI.

Indeed, regulators have repeatedly brought enforcement actions in precisely such scenarios. For example, in recent FINRA and SEC disciplinary actions, firms have been sanctioned for marketing non-traded REITs to elderly investors or others with limited liquidity needs, without proper disclosure or without an adequate understanding of the product's complexities. While earlier cases were often adjudicated under the suitability rule, Reg BI now provides an even more investor-protective framework for evaluating broker conduct.

Moreover, these obligations do not operate in a vacuum. Brokers may also face liability under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, which prohibit fraud, material misstatements, and omissions in connection with the sale of securities. Misleading investors about the nature or risks of REITs or failing to disclose that distributions are being paid out of offering proceeds rather than earnings may not only breach Reg BI but also constitute securities fraud under Rule 10b-5.

In light of these considerations, investors must approach REITs, particularly non-traded or private offerings, with a high degree of caution and skepticism. While these products are often marketed as stable, income-generating investments backed by tangible assets, the reality is that many are complex, opaque, costly, and illiquid. The potential for attractive returns must be weighed against the structural disadvantages inherent in these vehicles, including high upfront fees, limited exit options, and the risk that distributions may be unsustainable or based on borrowed funds rather than actual earnings. These concerns are not hypothetical; they are well-documented in regulatory actions and investor complaints across the country.

More importantly, investors should not assume that the involvement of a licensed broker or large investment firm guarantees that a REIT recommendation was appropriate or legally sound. Even today, retail investors are steered into REITs without full disclosure or adequate evaluation of their financial needs and risk tolerances. Regulation Best Interest, along with longstanding antifraud provisions like Rule 10b-5, provide a legal framework to hold brokers accountable, but enforcement often depends on the willingness of harmed investors to come forward and assert their rights.

Recovering REIT Investment Losses Through Legal Action & Arbitration

Investors who have been harmed by inappropriate REIT recommendations or who were misled by sales practices that violated Reg BI or other legal standards may be entitled to recover their losses. These claims are often pursued through FINRA arbitration, where investors can seek redress for broker misconduct, breach of fiduciary duty, material misrepresentations, and failure to disclose risks. At AMW Law PLLC, a securities-focused law firm, we have the experience to assess whether your investment was the result of a Reg BI violation, a fraudulent scheme, or a negligent recommendation that failed to reflect your financial needs and goals. We represent clients in pursuing claims against brokerage firms and financial professionals who breach their obligations under federal laws and self-regulatory rules.

At AMW Law PLLC, we are committed to helping investors understand their legal options and pursue recovery, including through securities arbitration, when those entrusted with managing their wealth fall short of their obligations. If you believe you have suffered losses due to REIT investments, whether through misrepresentation, omission, or a recommendation that failed to serve your best interest, we encourage you to contact our office for a free, confidential, no-obligation consultation. We will carefully assess your situation, explain your potential remedies, and advocate for the compensation you deserve.

Investor protection starts with information, but it succeeds with action. Let AMW Law PLLC, an experienced securities law firm, be your advocate in holding financial professionals accountable and safeguarding your financial future.