CJG, FINRA, Others Caution Against Non-Public REITs

The Consumer Justice Group joins FINRA in cautioning investors against non-public REITs and is prepared to discuss investment losses with anyone who purchased them.

Private REITs
There is another type of REIT—a private REIT, or private-placement REIT—that also does not trade on an exchange. Private REITS carry significant risk to investors. Not only are they unlisted, making them hard to value and trade, but they also generally are exempt from Securities Act registration. As such, private REITs are not subject to the same disclosure requirements as public non-traded REITs. The lack of disclosure documents makes it extremely difficult for investors to make an informed decision about the investment. Private REITS generally can be sold only to accredited investors, for instance those with a net worth in excess of $1 million. As with any private investment, it is a good idea to have the investment reviewed by an investment professional who understands the product and can offer impartial advice.

 

Complexities and Risks

 

When it comes to investing in non-traded REITs, selling points such as the opportunity for capital appreciation, diversification and the allure of a robust distribution can be enticing. But investors should balance these selling points against the numerous complexities and risks these investments carry.

 

  • Distributions are not guaranteed and may exceed operating cash flow. Deciding whether to pay distributions and the amount of any distribution is within discretion of a REIT’s Board of Directors in the exercise of its fiduciary duties. Distributions can be suspended for a period of time or halted altogether. Many factors may influence the composition of these payments. For example, in newer programs, distributions may be funded in part or entirely by cash from investor capital or borrowings—leveraged money that does not come from income generated by the real estate itself, such as rents or hotel occupancy fees. The REIT’s articles of incorporation often allow it to increase debt, dip into cash reserves and apply proceeds of the sale of new shares to sustain or even increase distributions. Some REITS even allow borrowing in excess of 100 percent of net assets. Leveraging, including the use of borrowed funds to pay distributions, can place the REIT at greater risk of default and devaluation, which can result in investment losses when it comes time to redeem or liquidate shares, as well as a reduction in, or suspension of, distributions.
    • Tip: Understand the REIT’s borrowing policies, outlined in the prospectus, and use the SEC’s EDGAR database of company filings to research how heavily leveraged the REIT may be, as well as how it is financing distributions. If Net Cash from Operations(what the company earns through its real estate alone) is less than the distribution (usually found in the Financing Activities section), then other sources, including borrowed funds, may be supporting the distribution. Before investing, be sure to ask the person offering the investment how much the REIT may have borrowed and whether the distributions include, or are likely to include, a return of principal. Ask how these factors might impact your investment. Keep these same factors in mind when deciding whether or not to reinvest distributions.
    • http://www.finra.org/Investors/ProtectYourself/InvestorAlerts/REITS/P124232
Even Seeking Alpha sounds a cautionary note on the subject:
If you are compelled to invest in commercial real estate, avoid non-public REITs. Why? Non-public REITs put you in a very inflexible position compared to publicly-traded REITs. Here’s how: non-public REITs are developed and marketed by the brokerage firm that sells them to you, and the internal cost structure is often as high as 16%. Even worse, once you buy into a non-public REIT, you are locked in. These REITs are entirely illiquid because you can’t sell them in the market if you don’t want to carry them anymore. Tying yourself into an investment with zero liquidity that is centered on an industry bound for trouble isn’t going to do any good for your portfolio.
Because market fundamentals are not fueling the activity in REITs, they are a speculative investment, and should be treated as such by investors. So, if you decide to plunge in, be very careful. Commercial real estate is going to be a drain on the recovery… don’t let it drag your portfolio down.
http://seekingalpha.com/article/193799-reits-are-a-gateway-to-a-troubled-market