REIT investors may have seen the term “capitalization rate” used in discussions of individual real estate property acquisitions and valuations and even in the broader market context when comparing investor expectations and property portfolio values. In this article we explain what capitalization rates or “cap rates” are and what they aren’t, and how nontraded REIT investors might interpret them. Investors expect both a return on their investment and a return of their investment. Both types of returns involve risk. Rational investors realize that higher expected returns involve more risk, which may mean less predictable returns or greater chance of loss.

Many investment professionals assume that it is better to invest in nontraded REITS later in their fundraising period rather than earlier. The recent study of full-cycle events by nontraded REITs performed by Blue Vault and the University of Texas McCombs School of Business The University of Texas at Austin, casts doubt on that assumption.

When recommending and choosing nontraded REITs for their clients, most advisors know the importance of looking at key metrics such as debt, distribution yield, MFFO payout ratios, and portfolio diversification. However, these metrics may vary greatly from REIT to REIT depending on where each program is in its life cycle.

In the recent study prepared in collaboration with The University of Texas called, “Nontraded REIT Industry Full-Cycle Performance Study” in addition to analyzing the total returns of the 17 nontraded REITs that went full-cycle between 1990 and March 2012, the findings also provided insights into what we might call “Timing versus Selection.”

Shareholders in nontraded REITs have limited options when attempting to liquidate some or all of their common stock holdings. While most nontraded REITs have share redemption programs, these programs may have been suspended due to liquidity issues or restricted to redemption requests filed due to death, disability or other hardships. Blue Vault reports on the redemptions of nontraded REIT shares by each REIT on a quarterly basis, but a more complete picture of the redemptions issue would require a comparison of redemptions request to redemptions granted. For example, CNL Lifestyle REIT redeemed 319,000 shares of the 9,726,000 pending redemption requests in 3Q 2012. Behringer Harvard REIT I redeemed 880,000 shares (0.3%) of the 299 million shares outstanding in 2012. KBS REIT I imposed a $10 million limit on redemptions for all of 2012 and redeemed 1.38 million shares (0.7%) of the 191.1 million shares outstanding at an average price of $5.58 per share.