Suitability for DPPs and REITs
With your understanding of Direct Participation Program (DPP) evaluation complete, the final piece is knowing which investors are appropriate candidates for these products, and which are not.
DPP Suitability Considerations
DPPs are not appropriate for every investor. The key suitability factors:
- Investor must have adequate financial resources to bear the risk of loss and illiquidity
- DPPs are suitable for investors in high tax brackets who can benefit from passive loss deductions
- Investors must understand they may need to hold the investment for the life of the program (often 7-12 years)
- The investor should have other sources of liquidity since DPP interests cannot be easily sold
DPPs Are NOT Suitable For:
- Investors who need liquidity or may need access to their capital
- Investors with low risk tolerance
- Investors in low tax brackets (the tax benefits provide less value)
- Investors who cannot afford a total loss of their investment
- Investors nearing retirement who need reliable income and capital preservation
Think of it this way: A DPP is like locking your money in a vault for 7-12 years. If you might need that money sooner, or you cannot afford to lose it entirely, a DPP is not for you. The tax benefits only matter if you are in a high enough bracket to use them.
Exam Tip: Gotchas
- A low-tax-bracket investor gets minimal benefit from DPP passive losses. The tax deductions that make DPPs attractive are worth much less to someone in a low bracket.
- The exam may present a retiree needing income and liquidity. DPPs are NOT suitable regardless of the projected returns.
REIT Suitability Considerations
Real Estate Investment Trust (REIT) suitability depends heavily on the type of REIT:
| REIT Type | Suitable For | Key Risks |
|---|---|---|
| Publicly traded REITs | Investors seeking income and diversification with exchange-traded liquidity | Market risk, interest rate risk |
| Non-traded REITs | Investors who can tolerate illiquidity and higher fees | Significant liquidity risk, higher fees, limited redemption |
| Mortgage REITs | Investors comfortable with interest rate sensitivity | Heightened interest rate risk compared to equity REITs |
Key Distinctions
- Publicly traded REITs provide the most liquidity and are suitable for a broader range of investors seeking real estate exposure and income
- Non-traded REITs carry significant liquidity risk and higher fees. They are suitable only for investors who explicitly understand and accept the illiquidity.
- Mortgage REITs carry heightened interest rate risk. When rates rise, the spread between borrowing costs and mortgage yields narrows, reducing profitability.
Exam Tip: Gotchas
- Non-traded REITs are NOT the same as publicly traded REITs for suitability purposes. Illiquidity is a major concern with non-traded REITs.
- Mortgage REITs have more interest rate risk than equity REITs. If the exam asks which REIT type is most sensitive to rate changes, it is mortgage REITs.
DPP vs. REIT Suitability Comparison
| Factor | DPPs | Publicly Traded REITs |
|---|---|---|
| Liquidity | Very low (7-12 year hold) | High (exchange-traded) |
| Investor type | High-net-worth, high tax bracket | Broad range of investors |
| Primary appeal | Tax benefits + income/appreciation | Income + diversification |
| Risk of total loss | Possible | Unlikely (diversified portfolio) |
| Tax bracket matters? | Yes; high bracket maximizes benefit | Less important |
| Minimum hold period | Life of program | None (can sell anytime) |
Exam Tip: Gotchas
- DPPs are for high-net-worth, high-tax-bracket investors who can accept illiquidity and potential total loss. If the question describes a moderate-income investor, DPPs are almost certainly unsuitable.