2013 saw regulators rushing to warn investors about the dangers of nontraded REITs. Despite the warnings, investors continue to find themselves trapped in unsuitable REIT investments. This year regulators took aim at several REITs and the brokerage firms that sold them.
Short for Real Estate Investment Trust, REITs are a popular way to invest in large real estate projects. Congress passed legislation in the 1960’s to allow investors to pool their money and invest in real estate. They were designed to provide an investment structure similar to the way mutual funds provide for investment in stocks. Because the tax code says that REITs must pay out at least 90 percent of their taxable income in the form of dividends, they are a good investment for those seeking income.
While REITs may provide excellent investment opportunities, there are multiple types of REIT products. Many are publically traded meaning you can buy and sell them like a stock. Private and nontraded REITs, however, typically have no secondary market meaning they are illiquid and sometimes must be held for a decade or more before one can sell.
Nontraded REITs may be suitable for institutional investors and pension funds but they are usually a bad deal for elderly investors and those needing access to their money. Stockbrokers like them, however, because they typically pay huge commissions.
Despite the warnings from the SEC, several states and the Financial Industry Regulatory Authority (FINRA), 2014 saw several enforcement actions related to these products.
In March, FINRA fined LPL Securities $950,000 for “supervisory deficiencies” related to the sales of alternative investment products, including non-traded real estate investment trusts (REITs), oil and gas partnerships and other illiquid pass-through investments.
Because of the inherent dangers of non traded REITs, several states and brokerage firms themselves have created concentration limits for these investments meaning a broker can only recommend that a limited percentage of a customer’s portfolio be invested in these products. Despite these limits, LPL was lax in making sure the limits were followed.
In February, FINRA fined Berthel Fisher & Company Financial Services, Inc. and its affiliate, Securities Management & Research, Inc for failure to supervise the sale of nontraded REITs. The companies also failed to properly train their staff on these products.
In our experience, many individual stockbrokers don’t understand the liquidity issues associated with these investments and fail to tell customers they could be stuck with the investment for years before they can sell.
In October, FINRA suspended an Ameriprise broker for improperly hawking a REIT investment through email solicitations. The broker was telling customers that an investment in a particular REIT was “doing well” even though the REIT’s largest property owner was in deep trouble.
Why do brokers make such claims? Commissions! Nontraded REITs carry very high commissions.
In February, four REIT projects affiliated with Apple REITs were fined $1.5 million by he SEC for failure to make key disclosures to customers and for not disclosing the compensation of key executives.
Non traded REIT projects are not only illiquid; they are often not transparent meaning it is hard for investors to understand fees being charged and to know what is happening within the investment.
The biggest nontraded REIT story this year will undoubtedly be about the czar of the industry, Nicholas Schorsch, and American Realty Capital. That story is still in its early stages but the allegations are stunning and the industry is reeling simply from the claims and the investigations.
The bottom line… Stockbrokers and the firms that employ them have an obligation to only make recommendations suitable for their clients. What works for one customer may not be a good fit for another. Nontraded REITs, however, are rarely appropriate for individual investors. There is good news, however. You may be able to get back your hard earned money if you a REIT product that lost value or that you are unable to sell or if believe the investment was never properly explained to you.
About the author: Brian Mahany is an attorney and the author of Due Diligence. He is a frequent contributor to REITlossrecovery.com.