Regulators Seek More Accurate Disclosures about Nontraded (Private) REITs


Nontraded (private) real estate investment trusts (‘REITs’) are highly risky for retail investors. These investments typically charge extremely high fees, are illiquid and are virtually impossible to value. The Financial Industry Regulatory Authority (FINRA) is reportedly finalizing a proposed rule that would decrease the time that broker-dealers have to estimated the value a nontraded REIT.

A nontraded REIT has no market value because, by definition, it is not traded on a market. But valuing a REIT or any business is complicated and fraught with uncertainty even when done by outside experts who may be qualified to undertake the task, and do so in good faith with no financial axe to grind. Previously, most nontraded REITs were listed at cost on account statements sent to customers. That was misleading because the real estate prices had plummeted, along with the true intrinsic value of REITs.

A nontraded REIT is a type of alternative investment often sold as a private offering or a Reg D offering (Reg D refers to the exemption from registration that is commonly used). Many of these offerings are very high-risk, and involve high commission payments and high fees. Serious concerns have developed about whether such investments are sold to investors because they generate high commissions, regardless of their unsuitability for the investors.

In October 2003, the NASD (FINRA’s) predecessor, sanctioned Wells Investment Securities for rewarding broker-dealer representatives who sold the company’s REITs, with lavish entertainment and travel perquisites, in violation of NASD rules. Leo Wells was also suspended from acting in a principle capacity for one year and fined $150,000.

Perhaps because of these types of incentives, broker-dealers often fail to perform adequate due diligence on the investments they sell. This is extremely risky for the small broker-dealers that sell nontraded REITs as well as their clients.

Many of the smaller brokerage firms that sold bad alternative investments have gone belly up. The list of failures includes MCL Financial Group Inc., QA3 Financial Corp., Jesup & Lamont Securities Corp., GunnAllen Financial Inc., Securities Network LLC, Omni Brokerage Inc., and WFP Securities. These firms folded under the legal costs of their failure to perform proper due diligence on the offerings.

In May, FINRA sued David Lerner Associates Inc. over the valuation of its Apple REITs, which were reported on customer account statements at the sale price, typically $11 a share. This was unreasonable and misleading to investors in the face of market fluctuations and other events.

The complaint alleged: “Since at least 2004, the closed Apple REITs have unreasonably valued their shares at a constant price of $11, notwithstanding market fluctuations, performance declines and increased leverage’. [and] despite the economic downturn for commercial real estate.”

The complaint also alleged that Apple REITs paid “outsized distributions of 7% to 8% by leveraging the REITs through borrowings and returning capital to investors.”

Over two years ago, FINRA issued a notice reminding its member firms of their obligation to list an estimated value on client account statements 18 months after the offering is closed to new investors ? rather than the purchase price. Eighteen months is a long time for investors to be without a bona fide valuation.

But REIT sponsors often extend the offering period to sell more shares to investors, which reportedly can result in four or five years passing before a nontraded REIT has a market valuation.

The FINRA rule proposal potentially would shorten that time period considerably and make it “more definitive,” an apparent reference to curtailing the extensions, according to a trade association spokesman. Nancy Condon of FINRA did not say when FINRA would publish the proposed rule for public comment.

The following is a partial list of non-traded REITS that we are investigating:

  • Apple REITs
  • Desert Capital REIT
  • Dubose Model Home (NetREIT)
  • Behringer Harvard REIT I
  • Inland Western Retail Real Estate Trust
  • NNN Healthcare Office REIT
  • AmREIT
  • Wells Real Estate Investment Trust II
  • Piedmont Office Realty Trust
  • Crystal River REIT

Brokerage firms that have been hit recently with arbitration claims for selling nontraded REITs without fully disclosing the risks include Linsco Private Ledger (LPL) and Ameriprise.

Atlanta attorney J. Boyd Page said: “We saw these same abuses in limited partnerships back in the nineties. High fees, illiquid investments, and false values. It was a bad mix for investors then and it is a bad mix for investors today.”

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 non-traded REITs and other private placement or Regulation D investments. For further information, please contact us.