What’s Your REIT Worth? Hint: The Answer May Not Be On Your Statement.

Risk management flow chartAnyone reading this blog knows we are not happy with the REIT industry. While REITs represent a great way to invest in larger real estate projects, stockbrokers and investment advisers have a terrible track record of placing investors into these products. We are not the only ones to hold this opinion. The SEC, FINRA (the Financial Industry Regulatory Authority) and the Massachusetts Division of Securities have all issued stern warnings to brokers about REITs.

Why? Because many investors don’t understand the risks and don’t appreciate that in many REITs, they may be forced to hold their investment for 10 years or more. Before anyone blames investors, the law requires stockbrokers and investment advisers recommending these products to thoroughly explain the risks. The law also requires that brokers only make investment recommendations if “suitable” to the investor’s financial situation and risk tolerance level.

The most dangerous REIT products are the nontraded REITs. As the name suggests, these investments are highly illiquid meaning it is difficult to sell your shares if you suddenly find yourself needing money. We cringe when we hear that some brokers are recommending these investments to people in their 70′s and 80′s. These folks may well die before the investment ever matures. And unlike a CD that you can cash in early and simply pay a penalty, there is no ready market for nontraded REITs.

Why would brokers recommend these products? The answer is easy. They pay high commissions.

One of the biggest names in the institutional real estate investment community is Tony Thompson. In the last year, Thompson has come under fire from regulators over his now defunct brokerage firm TNP Securities. He is personally fighting charges from FINRA accusing him of defrauding and deceiving investors.

Last week a leading investment industry news source, InvestmentNews, reported that the $270 million REIT, Strategic Realty Trust, bought out Thompson’s holdings in that company for $8.00 a share. We chuckled when we read the story because Strategic Realty Trust is a nontraded REIT. There is no ready market for its shares.

Many nontraded REITs claim a share value of $10. Are they really worth that? Is Strategic worth $8.00? No one really knows. The value of anything is only what someone is willing to pay. Look at real estate prices in Detroit where the city assesses some properties for 10 times what they are worth. The city can say a property is worth $100,000 but its real value is only $8,000 if that is all someone is willing to pay.

Why do we bring this up? In announcing the buyout of Thompson’s holdings, Andrew Batinovich, Strategic’s CEO, said, “The $8 per share is a negotiated transaction price and not necessarily a valuation of the shares. We felt it was important to take out his shares as part of this transaction. We do intend to get a third party [net asset valuation] after the March quarter closes.”

The story says he declined to comment about the REIT’s potential valuation. That says it all.

No one knows what some REITs are really worth. We say they are worthless if you need cash and can’t sell your shares. Brokers don’t want you to hear what we say but its true. If a broker recommended you invest in a nontraded REIT and didn’t explain the risks or told you it was suitable for your needs and now you can’t cash out, you may have a claim.

REIT fraud is a growing problem. Many mistakes made by brokers a few years ago are finally beginning to surface. These problems are what have prompted so many government authorities to issue stern warnings. Massachusetts took things to the next level and imposed caps on the percentage of one’s portfolio that should be invested in illiquid investment products.

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. We have seen instances of unscrupulous brokers recommending these investments to people nearing retirement, often with disastrous results.

Post by Brian Mahany. This post originally appeared on Due Diligence.

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