Non-traded REITs

Many people are aware of the real estate bubble that ran up real estate prices in the first half of the 2000’s decade but saw prices crashing in 2007-2009.    Wanting to get in on the real estate boom, many advisors recommended that their customers invest in REITs (or Real Estate Investment Trusts).  A REIT is a company that owns multiple (sometimes several hundred) pieces of real estate, usually income-producing real estate.  Investors then can purchase shares of the REIT company, hoping to get income generated from the underlying real estate.

Investors can purchase publicly traded REITs, which are available to be bought and sold on a nationally recognized securities exchange like the NYSE or NASDAQ.  Investors can also purchase REITs which are not available on a publicly traded exchange, and are referred to as non-traded REITs (or private REITs).  Unfortunately, non-traded REITs are fraught with issues that investors are not typically aware of.  FINRA (the Financial Industry Regulatory Authority) highlights some of those issues here.

Driving the sales of approximately $12 billion a year in non-traded REITs in past few years were massive sales commissions and fees, often running as high as 15%.  Unfortunately, non-traded REITs have the largest commissions of any product that a financial advisor could sell. The sales commissions, fees, and offering expenses for a non-traded REIT typically amounts to 15% to 20% of the amount invested.  It is comparable to driving a new car off the lot and immediately having 15% depreciation.

Given the myriad problems with non-listed REITs as more fully described below, the only reason billions are sold to investors each year are massive commissions in comparison to other investments.  In addition to the upfront commissions of 9% to 12% percent paid directly to the broker (with the rest going to the REIT manager), there are individual property/asset acquisition fees of up to 2.75%, property financing fees of up to 1%, management fees of up to 5%, disposition fees of up to 1%, and asset management fees of up to 1% per annum, plus additional expenses. The net result is that out of a $100,000 initial investment, only about $80,000 to $85,000 would be left to actually invest.  These massive fees create a commission vortex that caused sales of non-traded REIT shares and purchases of the underlying property at almost any price regardless of the quality.  Unfortunately, many retail investors have no idea how expensive these investments truly were.

Financial advisors often pitch these investments to elderly, conservative investors, representing that the returns of these non-traded REITs are stable.  Financial advisors often pitched these investments to their clients as being non-correlated to the stock market. However, like many investments, non-traded REITs can lose value (sometimes significant value) if the underlying real properties suffer losses or are foreclosed on.

What makes the commission and fee payout even worse is that many of these charges are hidden from investors.  As one example, the SEC settled a non-traded REIT kickback scheme with W.P. Carey.   According to the settlement, W.P. Carey paid nearly $10 million in undisclosed compensation to a broker-dealer that sold shares of W.P. Carey’s non-traded REITs to the public. The arrangement benefited not only the broker-dealer, but also W.P. Carey, because the broker-dealer’s sales of REIT shares increased the management and other operating fees paid to W.P. Carey. W.P. Carey and two senior executives agreed to pay $30.3 million in disgorgement, interest and penalties.

Ameriprise Financial Services also got fined for selling non-traded REITs.  The firm agreed in 2009 to pay $17.3 million to settle charges by the SEC that it received undisclosed payments to sell REITs to customers. According to the settlement with the SEC, sales of certain REITs provided the Minneapolis-based broker-dealer with $31 million in compensation.  SEC Enforcement Director Robert Khuzami said in a statement “Ameriprise customers were not informed about the incentives its brokers had to sell these investments.”  The SEC also found that Ameriprise issued a variety of mislabeled invoices to the REITs as a means of collecting the undisclosed revenue-sharing payments, making them appear as legitimate reimbursements for services provided by Ameriprise 

The dividend structure of non-traded REITs sometimes lulls investors into a false sense of security that everything was fine with their investment. With non-traded REITs, the dividend is sometimes greater than the operating cash flow generated from the real estate.  Yet what is distributed is still called a “dividend”.  If the underlying real estate cannot generate cash from operations sufficient to meet the represented dividend, then other cash sources are used including loans, cash reserves, and proceeds from the sale of new securities and/or assets.  Even if the articles of incorporation for the non-listed REIT permit the use of such cash sources, if the “dividend” exceeds operating cash flow, the REIT is eroding assets or increasing debt to pay the “dividend” and thus jeopardizing capital preservation and appreciation. 

One of the biggest problems with non-traded REITs for investors approaching retirement is the lack of liquidity.  FINRA has warned brokerage firms on multiple occasions that the liquidity of an investment is something that must be taken into consideration before making a recommendation. See NASD Notice to Members 03-71. Some non-listed REITs promise a redemption program where a small portion of the outstanding shares are purchased by the REIT each year, often at a price approximating book value. But often the investments were sold to clients who needed access to a much greater percentage of their investment like they would have with a typical mutual fund.

Typically, non-traded REITs have a very limited and private trading market.  In such a market, third parties offer to purchase shares of non-listed REITs, sometimes at significant discounts to the initial offering price or book value.  In addition, the seller pays fees to the intermediary firm that facilitates the transaction, and sometimes a transfer fee to the REIT. Even if the investor is willing to accept the steep discount, liquidity is not guaranteed.

Israels & Neuman PLC is a securities law firm with offices in Denver, Colorado and the Seattle area.  We represent investors in FINRA arbitration proceedings in all 50 states.  Our attorneys have represented over one thousand investors against many brokerage firms in the past, including LPL Financial, Merrill Lynch, Morgan Stanley, Smith Barney, Stifel Nicolaus & Company, UBS Financial Services, Oppenheimer, Charles Schwab, Wells Fargo Advisors, Ameriprise Financial Services, Raymond James Financial Services, ProEquities, Securities America, National Securities Corp., and many others.  All of our investment loss cases are taken on a contingent basis, meaning that we do not get paid unless we recover money for you.


             Aaron Israels: (720) 599-3505

             David Neuman: (206) 795-5798