For several years, regulators have talked about toughening up rules on nontraded REITs. There are many ways to invest in large real estate projects. Real Estate Investment Trusts – REITs – are especially popular because they let ordinary investors pool their money and invest in shopping centers, apartment buildings and office parks. Not all REITs are created equally, however.
Many real estate trusts are traded on a national exchange. Investors can find what their shares are worth with just a few keystrokes. More importantly, they can liquidate their investment if there is a sudden need for cash.
Two of the most popular REIT types are private and nontraded REITs. Unlike their publicly traded cousins, there is often no way to determine their value and sometimes the investment must be held for a decade or more before there is a liquidity event.
Why? Because they are not traded, there is no ready secondary market for the shares. An investor must wait until the trust decides to go public or sell off its assets.
Enter the regulators. Several states have already imposed concentration limits on non-traded REIT shares. These limit how much a broker can recommend to an individual investor client. The customers, of course, can do whatever they wish with their funds but brokers can’t assist or recommend an investment more than the state imposed limit.
Now the Financial Industry Regulatory Authority (FINRA) has proposed its own rules on nontraded REITs and direct participation investments. Under regulatory notice 2014-006, FINRA proposes:
1. A new regimen for disclosure of organization and offering costs.
2. A requirement that valuation methodology be consistent with industry standards.
3. Earlier determination of net asset value.
4. Independent-party assistance and confirmation of net asset value.
5. More frequent determination of valuations.
Many stockbrokers and brokerage firms don’t like the proposed regulations. We believe these firms worry that the new rules will hurt their profits. Nontraded REITs pay commissions far above average. Their internal fees are often higher too.
Not everyone in the industry dislikes the proposal, however. According to a story in InvestmentNews, Mark Goldberg, chair of the Investment Program Association, enthusiastically supports the new rules. We do as well, although we think they don’t go far enough.
Addressing valuation issues in these otherwise opaque investment vehicles is a necessary first step. FINRA’s proposed rules addresses that problem. Better disclosure of commissions and fees – and a comparison of these numbers to publicly traded REITs – should also be addressed.
Existing know your customer and suitability rules address the issue of brokers recommending these illiquid investments to seniors and retirees. Those rules should be better enforced., however
That’s our two cents. We are glad to see that some folks in the industry understand that nontraded REITs continue to be a problem.
Lose money in a nontraded REIT or other illiquid alternative investment? Give us a call. Brokerage firms are responsible for the misconduct of their brokers and advisers. Most cases can be handled on a contingent or “success” fee basis.