December 22, 2024

Square Feet: A Closer, and Skeptical, Look at Nontraded REITs

Cole took this unusual step after the Townsend Group of Cleveland, an adviser to the state pension board, reviewed the investment at the request of public officials and said it was unsuitable for a pension fund. Townsend’s long list of reasons included the excessive fees paid by investors and the company’s lack of liquidity and “appropriate policies for investment valuation,” public documents show.

The events in West Warwick brought unwanted attention to a relatively small and little-known sector of the real estate industry that has been around for more than a decade but has grown rapidly in recent years. Nontraded REITs are securities that are not listed on any exchange and are sold through financial advisers, which receive generous fees. Recently, this sector has been receiving heightened scrutiny from both the Securities and Exchange Commission and the Financial Industry Regulatory Authority, or Finra.

In May, Finra filed a complaint against David Lerner Associates, a broker-dealer in Syosset, N.Y., accusing the company of aggressively marketing $300 million worth of shares of the nontraded Apple hotel REIT to unsophisticated and elderly customers without telling them that the income from the stock was insufficient to support the dividends. Lerner has called the charges “baseless.”

Since 2004, the nontraded real estate investment trust sector has more than doubled and now has more than 63 sponsors, according to Blue Vault Partners, a research firm in Cumming, Ga. Last year, these sponsors raised $8.5 billion, a 30 percent increase over 2009. As much as $10 billion may be raised this year, approaching the $11.8 billion in investment at the peak of the market in 2007, Blue Vault said.

Like their publicly traded counterparts, nontraded REITs invest in real estate and are supposed to distribute at least 90 percent of their taxable income to shareholders annually in the form of dividends. REITs generally pay no corporate income tax.

But critics of nontraded REITs say there are a number of troubling features about the trusts, including high upfront fees that lower the value of the investment by as much as 17 cents on the dollar. Sales commissions and fees are typically 9 to 10 percent, and there are also charges for leasing, management and acquisition of commercial buildings. Critics also cite a lack of transparency about how the companies value their real estate holdings, inherent conflicts of interest because the sponsor generally invests little in the REIT but owns the entity that collects the fees.

Investors are told that nontraded securities, which have limited liquidity, allow ordinary people to participate in real estate investment while earning a higher dividend than what the traded ones offer, free from the volatility of the stock market. According to this pitch, investors are spared the anxiety of worrying that their shares, usually sold at $10, will go up and down.

Stacy H. Chitty, a former nontraded REIT executive who is now a Blue Vault partner, said much of the fluctuation in the stock market was driven by emotion. “It’s this little occurrence here, this little occurrence there,” he said. “Share price is not an accurate picture. In nontraded instruments you don’t have that daily up-and-down swing. It’s a long-term proposition.”

But nontraded trusts are now required to update their net asset values every 18 months after their initial offering, and their own disclosures to the S.E.C. show their values dropping well below the price at which the shares were originally issued. For example, one REIT, American Realty Capital Trust, recently reported that its shares, which had been sold at $10, were now worth $6.62. The sponsor, American Realty Capital of New York, raised $2.3 billion in the last 18 months, according to its chief executive, Nicholas S. Schorsch. Other sponsors, including Cole, have reported similar declines in share price, public records show.

“One common sales tactic we object to is the suggestion that they are eliminating volatility simply because they don’t tell you what the value is,” said Michael McTiernan, a lawyer for the S.E.C.’s corporate finance division. “It’s not that it’s not volatile. It’s just that you don’t know.”

Article source: http://feeds.nytimes.com/click.phdo?i=8ada12391d505fa56421908d5db32572

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