Understanding Unusual Investments

February 1, 2010
Janet Kidd Stewart

Are exotic investment vehicles right for you? Here’s the scoop on what to watch for as you consider unconventional ways to invest your money.


Doctors and other high-income professionals seem to bump into unconventional investment ideas with surprising regularity.

Wherever there’s an oil and gas partnership, a managed futures play, or a new hedge fund, there seems to be a line of physician investors forming - or at least a line of financial “advisers” ready to sell those products to physicians.

It’s only natural, really. Exotic investments appeal at once to those twin drivers, greed and fear. Sometimes they promise better returns than the masses can achieve with mutual funds. Or when traditional markets grow volatile, they are the point of refuge. Because the requirement for many of these alternatives is a certain minimum net worth and income to play, investors find them particularly alluring. For investors who may be playing catch-up on savings after years of medical school loans, their appeal is palpable.

Risky real estate

Like anything else “exotic,” however, they also carry a whiff of danger. Could high fees, long lock-up requirements on the money, and looser regulation chip away all the initial advantages? Those are good questions to ask about any investment pitched to affluent investors, and definitely about real estate investments known as unlisted or nontraded Real Estate Investment Trusts (REITs) that have been gaining in popularity with affluent investors in recent years.

Unlike publicly traded REITs (pronounced reets) that trade like stocks on an exchange and see their closing share prices fluctuate daily, nontraded REITs are companies that don’t trade on an exchange. They buy and own properties - medical office buildings, for example - and pay out dividends to investors. After a period of several years, the company liquidates and sells off the properties to raise cash or initiates a public share offering of the portfolio, both to pay back initial investors. Hopefully, the payback includes a profit big enough to compensate for the long holding period, which typically lasts five to 10 years, and all the fees generated through the ownership process, which can approach 20 percent of initial investment.

“We like them a lot, though you need to be very careful,” says Carrie Coghill Kuntz, cofounder of D.B. Root & Co., a financial planning firm in Pittsburgh. Kuntz says investors should scrutinize the track records of the real estate companies behind these deals, know their substantial costs, and make sure the people selling them have a lot of experience in the field. Despite those cautions, her firm last fall increased its clients’ exposure to nontraded REITs from up to 15 percent to as high as 20 percent of investors’ overall portfolios. With real estate in a downturn, Kuntz is betting on a rebound for investors getting in now who will hold their properties for several years.

This is definitely a more opportunistic, aggressive investment play than it was a couple of years ago, she says. When real estate is stable, nontraded REITs make more sense for retirees and other investors who are seeking stable income in the form of dividends, with less expectation for a big upside at the end.

And she acknowledges a host of caveats, including a crowded field of inexperienced sales people pushing the products since their popularity started shooting up in 2007. (Sales surged to $9.1 billion in 2008 before scaling back in 2009’s real estate downturn, according to Robert A. Stanger & Co.)

“I spoke at an industry conference last year and was amazed how many sponsors were just getting into this,” Kuntz says.

Be wary of leverage

Another red flag to watch: leverage.

Investors need to look closely and ask questions about the way projects are being financed today, experts say.

Well capitalized projects are preparing for an extended real estate downturn by reducing leverage and avoiding cross-collateralization, or using one giant blanket mortgage for a group of properties, says Michael P. Black, a Scottsdale, Ariz., financial adviser who has invested in many unlisted REIT offerings himself and for clients.

Despite all the warnings, the investments have provided reliable dividends for clients when nearly everything else was tanking and typically offers nice upside as well, says Joseph Zarlenga, an Ameriprise financial adviser in Naperville, Ill. His firm is also looking at other alternative investments for clients, including lines of credit extended to mid-sized businesses that generate dividends during the loan period.

Although most nontraded REITs are not technically private placements that require accredited investor status, most sponsors of the investment voluntarily impose those standards ($250,000 in net worth or $70,000 in income and $70,000 in net worth). The standards help firms establish that they sold investments that were suitable to their investors.

In addition to those requirements, firms often restrict investors from putting more than 20 percent of their assets in these vehicles.

Despite warnings about illiquidity at the time of sale, investors inevitably have unexpected expenses arise, such as divorce, that require immediate cash, says Black, who is also a divorce financial planner. This can result in an investor having to attempt to sell his position on the secondary market, typically for less than half what he paid.

However, when investors go in with their eyes wide open, Zarlenga says, the results can be very positive.

“Protecting your down side is a very hard sell,” he says. “Sure, in a down market everyone loves it. But in an up market they’re asking, ‘why are we doing this?’”

Knowing your investment objectives, watching out for tax issues on the dividends, and scrutinizing fees on these deals won’t completely eliminate the risk involved - but they may help you maximize your rewards.

Janet Kidd Stewart is a freelance writer based in Marshfield, Wis. As a contributing columnist for the Chicago Tribune, she writes a weekly, syndicated retirement column called “The Journey” that appears in Tribune newspapers across the United States. She holds a bachelor’s degree and master’s degree from the Medill School of Journalism at Northwestern University. She can be reached via physicianspractice@cmpmedica.com.
This article originally appeared in the February 2010 issue of
Physicians Practice.