Unlisted, private REITs have been the subject of many abuses and investors face losing their shirts in these investments. The recent demise of Apple REIT investments underscore the dangers. “Owning hotels is anything but a safe, volatility-free way to invest money,” but that is not what broker-dealer David Lerner Associates (“DLA”) told its clients, according to articles by Floyd Norris entitled “Statements Skip Over REIT’s Woes” (NY Times) and in InvestmentNews entitled “Bad tip from Poppy? Finra files complaint against David Lerner Associates.”
DLA, which advertises heavily in Florida and New York, sold an unlisted REIT named Apple REIT to its elderly and unsophisticated customers. It was sold to them as a stable alternative to the volatile stock market, which they feared. But the REIT only appeared to be stable because it was illiquid (little or no trading occurred to establish a market value), and DLA’s monthly statements for Apple REIT EIGHT stated that the investment was worth $11.00, exactly what most of them paid for it (some earlier investors bought at $10.50 so it appeared to have a gain.)
In fact, Apple REIT EIGHT is in trouble and its value is far less than $11.
Commercial real estate has tanked since 2007, when the first investors were sold their shares. The REIT has failed to make mortgage payments on four hotels it owns, and may have to surrender the properties to the lenders. Since distributions have far exceeded income, monthly payouts to investors have largely been funded by borrowing, which is more difficult now (the last loan was made subject to a personal guarantee). A recent tender offer for up to 5% of the outstanding shares offered $3.00. Yet DLA has not written down the values of those hotels on the statements it send to its clients.
“Who knows what the value is?” Apple CEO Knight was quoted as saying, adding: “I would not be comfortable in saying it was $4, $5, or $6. If I said I could sell it for $12, I would be sued.”
The Financial Industry Regulatory Authority directed broker-dealers to value untraded REITS on information no more than 18 months old. Most nontraded REITs have now lowered their market value to an amount well below the offering price. The Apple REIT funds “are the only funds” to stick with the offering price, according to the article.
DLA has a troubling history of fines and disciplinary actions against it. FINRA filed a disciplinary action against it recently saying that DLA was misleading and “targeting unsophisticated and elderly customers with unsuitable sales of this illiquid security” and misled them regarding the record of earlier Apple funds.
DLA’s combative reaction may have contained a Freudian slip: “What is obvious is that D.L.A. and other small firms have become the scapegoats for Finra’s utter failure to address Madoff’s fraudulent scheme.” The article points out that “Madoff [also] preyed on wealthy investors who wanted good returns without volatility.”
Overall, the untraded REIT business is big. Sales were 11.8 billion in 2007, $6.4 billion in 2009, and $8.3 billion in 2010.
DLA has sold nearly $6.8 billion of Apple REIT shares to over 122,000 customers since the early 1990s, including more than $300 million of Apple REIT TEN.
As always, high commissions and fees drive sales of unlisted REITS ? 12% or more for Apple REIT. DLA makes most of its money from selling Apple REIT, according to the article.
“These things pay an unbelievable commission to the broker,” Barry Vinocur, the editor of REIT Wrap, a newsletter, was quoted as saying, adding: “The client ends up with a phenomenally uncompetitive investment.”
Richard Ketchum, chairman and chief executive of the Financial Industry Regulatory Authority (FINRA) recently advised broker-dealers that sell risky private placements to conduct more rigorous due diligence, warning that FINRA is focusing on Reg D offerings.
Perhaps because of the exorbitant commissions and fees, broker-dealers often fail to perform adequate due diligence on the investments they sell. This can be risky to the broker-dealers as well as their clients, as many of the now-defunct B-Ds that sold Provident Royalties and Medical Capital private offerings can attest.
In the case of DLA, its current legal problems raise a question as to whether it has (or will have) sufficient assets to pay an arbitration award. It is a question that should be examined at the outset before filing an arbitration claim.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 45 occasions. Page Perry’s attorneys have extensive experience in representing investors in cases involving private placement or Reg D securities. For further information, please contact us.