Addressing the Valuation Problems Associated with Nontraded REITS

HOTEL-REITAs readers of this site are unfortunately well aware, one of the many problems associated with a nontraded REIT is that of unknown valuation. For too long the default pricing of a nontraded REIT has been $10.00 per share. That is $10.00 per share regardless of all factors. That is $10.00 per share even though at least 10% of the initial share price (ie. $1.00) often goes to selling commissions paid to the broker-dealers and advisors who are paid to sell their clients nontraded REITS. In the investment community the $10.00 valuation for nontraded REITS has long been an inside joke.

Well, at least part of the joke may be up. In a recently filed rule proposal, the Financial Industry Regulatory Authority (FINRA) has proposed that one of two valuation methodologies be used to value nontraded REITS. The valuation methodologies are net investment and independent valuation.

A net investment valuation takes into account the money that actually flows to property purchases or investment and attempts to differentiate money spent towards investment and funds expended for other things such as commissions paid. Under the FINRA proposal a nontraded REIT could use the net investment valuation for two years after the REIT breaks escrow or in other words puts its funds to use purchasing real estate. An example of how the net investment valuation would look is provided by FINRA in its proposal; “if the prospectus for an offering with a $10.00 offering price per share disclosed the selling commissions totaling 10% of the offering proceeds, and organizational and offering expenses of 2%, the amount available for investment would be 88%, or $8.80 per share.” This is a vast improvement over the current rules that do not mandate an estimated per-share valuation until 18 months after the sponsor stops raising funds, which often times can amount to a few years.

The other valuation method is independent valuation which can be utilized at any time. This method is as straight forward as it sounds and provides for an independent valuation of the nontraded REIT.

It is important to note that the latest FINRA rule proposal is just that, the latest proposal of FINRA. FINRA has been working on the issue of nontraded REIT valuation for several years now. It is now up to the Securities and Exchange Commission (SEC) to approval the FINRA proposal. If the SEC approves the proposal then the new rule would take effect shortly thereafter.

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