Our attorneys have extensive experience handing disputes concerning non-traded REITs. These cases often involve situations where the clients are misled about the basic features of the REITs, including its liquidity, safety and correlation to the overall stock market. If you have questions about your non-traded REIT, please contact one of our attorneys at 212-203-9300 for a free and confidential consultation.
Conflicts of interest like these are far more prevalent in the financial industry than most people realize. A 2015 government task force report estimated this “conflicted advice” costs American investors over $17 billion every year.
While conflicted advice can be found in many parts of the financial world, one growing area has recently garnered the attention of the regulators. That is an investment class called non-traded REITs. Our attorneys have handled dozens of FINRA arbitration matters involving illiquid, non-traded REITs.
REIT stands for Real Estate Investment Trust. A REIT is a company that owns, operates, or finances income-producing real estate. The idea is similar to a mutual fund but applied to real estate. Capital from many investors is pooled and deployed to diversify and reduce risks inherent in any one project. REITs invest in various property types, including apartment buildings, office buildings, shopping malls, hotels, hospitals, and more.
REITs are nothing new or obscure; REITs are bought and sold every day on the big stock exchanges. REITs are popular since they allow investors to diversify into real estate without the hassles involved in direct property ownership. REITs also enjoy unique tax benefits, which can be especially attractive to higher-income investors.
But there’s another type of REIT out there that is not public, so it’s different from most investments individuals are familiar with. These are called “non-traded” REITs.
A non-traded REIT cannot be bought or sold on an exchange or through a regular brokerage account. Instead, it must be purchased directly through the investment company. So it lacks liquidity, meaning once you purchase it, there’s no fast or easy way to sell it.
On the other hand, a public REIT on a stock exchange trades just like any other stock, so you can buy or sell it fast and easily, usually within seconds.
These non-traded REITS are increasingly common: one investment bank reported that in 2020 alone, over $10.8 billion of these investments were sold.
Here’s the problem: since these REITs are not on exchanges, they need exposure. They get it by offering a commission to financial advisors to recommend their products to clients.
And the commissions can be considerable. According to an Investor Bulletin put out by the Securities and Exchange Commission, commissions can add up to 15% of the investment. That juicy commission, unfortunately, can be difficult for less than ethical financial advisors to pass by. So instead of just offering it to those best suited to handle the risk of these investments, they may suggest it to those who don’t have the experience or time to question their recommendations.
Frequently, these non-traded vehicles are said to have certain advantages:
Most REITs do pay a higher distribution, often dramatically higher than other fixed-income yields. This can be extremely attractive in these low-interest rate times. Of course, with a higher return comes more risk. Returns on REITS can be volatile and are not guaranteed. In addition, the investment can lose value as well.
Regardless, REITs are a popular way for investors to diversify outside of stocks and bonds. And they can be appropriate for high-income investors who are willing to take more risk to increase income and diversify. However, these non-traded REITS can involve risks far beyond what an average investor may expect.
Here are the concerns to be wary of if you’re considering investing in a non-traded REIT.
With commissions of up to 15%, that means that less of your money is working for you right from the start. But that is not the only fee you’ll face. In addition to high upfront commissions, these non-traded REITs may also have significant transaction costs, such as asset management and property acquisition fees. Every dollar you pay in fees represents an additional dollar you need to make up to break even on your investment.
With most publicly traded investments, you can sell your shares within a short amount of time, usually a matter of seconds. Not so with these non-traded investments. Instead, selling is different as there is not necessarily a market for these shares. So you may need to wait until this non-traded REIT decides to list its shares on an exchange or wait for it to liquidate its assets in the future. As you may have guessed, this may leave you waiting a long time, sometimes a decade or more.
Some of these investments may offer you an opportunity to sell your shares early via a redemption program. However, these are usually limited and may be discontinued without notice. They also may involve a significant discount.
Especially if there’s bad news or a change of overall trend, these non-traded REITs may leave you stuck with a declining investment that you can’t sell.
With non-traded REITS, you may not get the quality or quantity of reporting that you may have come to expect from publicly listed companies. In some ways, you are flying blind as an investor. You will be dependent upon the company to provide updates voluntarily. This can have even worse repercussions. For example, these REITs often purchase much of the portfolio of real estate after initial fundraising. Since there’s little reporting, you have little visibility on how investor money is being spent and if new projects are being purchased at reasonable valuation levels.
Investors are usually attracted by the high distributions promised by these REITs. Did you know that some of these payments may be a return of principal (instead of being paid from earnings)? This can happen in the early years of the investment before the REIT has acquired assets. So, in this case, you’re simply getting some of your investment money returned to you. This reduces the value of your shares as well as the cash the REIT has to purchase assets.
As you can see, there are several issues with non-traded REITs. Can they still be a good investment? Yes, but only if you can determine there are minimal conflicts of interest and that the management is committed and experienced enough to manage the venture effectively.
Let’s review the potential conflicts of interest involved.
First, as previously mentioned, you’re going to pay a commission to buy the investment. As previously noted, these are not small percentages. A FINRA department of enforcement complaint documented one financial advisor received over $450,000 in commissions from the sale of non-traded REITs.
But even after a portion of your investment goes to pay commissions, you’re not necessarily done with conflicts of interest. Many of these investments carry additional high transaction fees, organizational costs, and management and acquisition fees. While these fees may not be acceptable in a publicly-traded REIT, you don’t have those controls in these non-listed entities.
You may be able to sell a non-traded REIT through a broker-dealer auction. Unfortunately, most investors in non-traded REITs will never recover their principal. These investors are left with no options other then filing a claim through an attorney against their financial advisor.
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