Brokerage firms that sell nontraded REITs reportedly “cringe” at Investor Alerts posted by the Financial Industry Regulatory Authority (FINRA) warning of the dangers of those products. They know that such alerts cause investors “anxiety and concern,” as they learn about the risks that were not disclosed to them by their brokers. Brokerage firms routinely fail to disclose material risks about the nontraded REITs they sell for two reasons: (i) they failed to inform themselves of the risks by conducting appropriate due diligence, and (ii) they don’t want to cause potential investors any “anxiety and concern,” because that would be bad for sales, which pay hefty commissions to the sellers. (“Non-traded REITs face tough scrutiny,” InvestmentNews).
FINRA issued its Investor Alert about the risks and problems associated with nontraded REITs in October. FINRA did so because it believes that selling firms are not disclosing those risks to potential investors. The risks include, but are not limited to, lack of liquidity, inadequate due diligence, improper valuations, improper pricing, and the fact that dividends are not guaranteed and typically are paid with investors’ own capital or borrowed funds, at least initially.
Industry representatives responded by arguing that: (i) lack of liquidity is beneficial in keeping investors from cashing out at the lows ? i.e., when the underlying real estate crashes; (ii) the industry is “evolving” with changes being driven from both inside and outside the industry (translation: the industry is on regulators’ radar screens because of abusive sales practices and bad products and is spinning like mad); and (iii) the industry may create different share classes to shuffle and hide the sales loads like many mutual funds did.
One industry representative claimed that nontraded REITs are not closely correlated with the stock market: “The nonlisted REIT is not going to respond to the ebbs and flows of the stock market.” But equity REITs have an 80 percent correlation with the S&P 500 stock index, according to Smart Money Magazine (“Don’t Rush Into REITS,” Amanda Gengler).
Selling brokers are required to be upfront about the risks with potential investors. Concerned that this is not being done, FINRA advised its broker-dealers: “Be upfront with customers and discuss the risks associated with it, such as the lack of liquidity.”
Nontraded REITs will ultimately be forced to disclose that valuations being reported at cost are actually much lower due to, among other reasons, mismanagement and the terrible real estate market.
Page Perry is an Atlanta-based law firm with over 170 years collective experience protecting investor rights and fighting Wall Street greed.