In the period from 2008 to 2011 REITs face challenges from both a slowing United States economy and the global financial crisis, which depressed share values by 40 to 70 percent in some cases. As a result, many investors have seen their REIT investments plummet in value, despite promises from their brokers and financial advisors that REITs are a "conservative" or "stable" income producing investment. Recent events have proven otherwise.
A Real Estate Investment Trust (REIT) is an entity that invests in real estate deals, and which usually offers shares for sale to the investing public. Some REITs are publicly traded companies, some are not. Some are sold to investors as privately held partnerships. REITs are primarily in the business of buying and managing real estate and must distribute most of their profits each year to investors.
REITs may own or invest in real estate, real estate-related loans or both. Though all REITs must meet a set of IRS conditions to qualify as REITs, they fall into three broad regulatory categories. One of these is a "public listed" REIT, which is registered, generally with the SEC, and publicly traded. The second is a "public unlisted" REIT, which is registered, but not listed or traded on an exchange. The third is a private placement REIT that is neither registered nor traded on an exchange. Private placement REITs often file an SEC "Reg D" form that exempts them from most disclosure documents, and thus their marketing is largely limited to wealthy or "accredited" investors.
REITs normally qualify with the IRS as a real estate company that agrees to pay out at least 90% of its taxable profit to investors (and meet other important requirements). REIT normally avoid corporate income tax if they meet IRS rules. REITs distribute nearly all of its profits and in return is not taxed on profits.
Real Estate Investment Trusts (REITS) are often sold by brokers in the past few year as conservative, income producing investments. However, REITs normally pay brokers relatively high commissions and expenses giving brokers to sell nonpublic REITs as stable, income producing investments appropriate for retirees and near retirees. The fact is that REITs have significant risks: lack of liquidity, lack of transparency, and full of expenses that benefit the sponsors and brokers that sell them.
REITs are regulated. However, even if a non-traded REIT gets a state's clearance to go public, that doesn't mean the offering is clear of risks. Often, it is up to financial advisors to determine whether the investment is appropriate for clients.
Some of the public non-traded REITs, pay distributions from the offering proceeds or borrowings. Customers may not be aware this signals that the REIT might be short on cash.
Federal regulators sometimes have acted on these controversial deals. In July 2009, Minneapolis-based Ameriprise Financial Services Inc. agreed to pay $17.3 million to settle SEC charges that it received millions of dollars in undisclosed compensation as a condition for offering and selling REITs to its brokerage customers. These offerings included $100 million of unregistered REIT shares. In recent years, the Financial Regulatory Authority (FINRA) began reviewing broker-dealers' sale and promotion of non-traded REITs-both public and private placements-in a targeted examination request.
FINRA member notice 09-09 issued in February 2009 clarified the rules on public and private placement non-traded REITs. Member firms, FINRA says, may not use par value in a customer account statement for more than 18 months after the conclusion of an offering. Plus, before participating in a public offering, they must determine whether all the material facts have been adequately and accurately disclosed-including whether the promised dividend distributions are sustainable.
Jeffrey Sonn, Esq., who represents investors in REITs, says that high commissions on private REITs provide a large incentive for REITs to be heavily pushed and inappropriately sold to some investors. "Brokers too often tell customers that it is a safe income producing investment without warning of the true risks, such as a lack of liquidity," said Sonn. "It's a good deal, they often say," added Sonn, "but that's not necessarily true."
Because nonpublic REITs are not traded publically, REIT managers determine the value of the portfolio themselves, as opposed to free market valuation. This creates a conflict of interest with the managers who selected the properties for the REIT being the same ones that determined their value. The higher the share price, the higher the management fee for the REIT managers. However, when investors try to sell their nonpublic REIT, they sometimes find that brokers get them quotes below the value on their statements, or they cannot sell them at all.
Investors who have been duped into buying nontraded REITs may have significant claims against their brokers. For more information, contact Jeffrey Sonn or Jeffrey Erez at Sonn & Erez PLC, 866-372-8311, or at jsonn@sonnerez.com or jerez@sonnerez.com.
