Non-Traded REITs – $20 Billion Per Year And Growing (so are the REIT Losses)

WINNER-LOOSERAccording to InvestmentNews, a leading securities industry trade publication, a record $20 billion in new non-traded REIT investments were sold last year. That number is nearly double the $10.3 billion sold in 2012. While many of these investments are solid, too often brokers are selling them to the wrong people. Unfortunately, that means REIT losses are growing at a record pace as well.

REITs have enjoyed enormous popularity because interest rates on traditional investments such as bonds and certificates of deposit remain very low. Because of unique tax advantages and a rising real estate market, REITs are a popular alternative to low interest, low risk investments. Stockbrokers love them to because they pay much higher commissions.

Unfortunately, many of the REITs sold these days are “non-traded” meaning they can’t be bought or sold like normal securities and mutual funds. Buy one and you may have to hold on to it for many years before you can sell. Since there is no market for these non-traded REITs, it is also harder to value them. Frequently they are worth far less than one’s statement would suggest.

A recent editorial in InvestmentNews calls these nontraded REITs “murky” and “opaque”. We think those terms are an understatement and fail to address the larger suitability problems surrounding these investments.

Bad brokers continue to sell these investments to unsuspecting investors. There is nothing wrong with nontraded REITs if sold to the right people and if properly explained. Because they can be very hard to liquidate, they shouldn’t be sold to retirees, the elderly and others who need ready access to their money.

The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission have proposed modest rules regarding how these investments should be valued. As noted above, it is hard to determine the value when there is no ready market. Regulators want to at least make the market less opaque. With better transparency, the high commissions and fees will also become more apparent.

Sounds reasonable, right? Apparently the industry is worried. According to InvestmentNews, “The broker-dealer industry has a lot at stake regarding these new rules. Many had record revenue from nontraded REIT sales last year, and they are worried that the new rules could hurt future sales if investors are seeing account statements that explicitly show the fees and commissions being charged for these investments.”

To us, that is a giant red flag. Financial advisers, compliance officers and brokerage firms all have an obligation to properly explain these investments including the high commissions charged for them, the lack of liquidity and the valuation problems. If they had been doing this all along, there would be no worry of the new rules. Unfortunately, we know of many investors who have no clue that their investment is illiquid or worth far less than their statement shows.

REIT fraud is a growing problem. Many mistakes made by brokers a few years ago are finally beginning to surface. These problems are the reason that FINRA, the SEC and states are proposing too tighten the rules.

The bottom line? The nontraded REIT industry is poised for another record year in 2014. Unfortunately, some brokers continue to sell these products to the wrong investors and many brokers fail to properly explain the risks and valuation problems. Non-traded REITs and private REITs are generally not suitable for investors who may need access to their money in the short or medium term.

About the author.  Brian Mahany is an attorney and the author of Due Diligence.

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