Real estate private placements and non-traded REITs: risks, regulations and investor warnings
By Bradd MiloveIn last month’s column, we addressed new FINRA regulatory action concerning
non-traded REITs, or real estate investment trusts, and the possible risks involved in these investments for unseasoned or unsuspecting investors. But as we move into 2012, analysts see little chance of eliminating these superficially attractive yet often dangerous investments from the marketplace – making further coverage and consideration of such dealings a necessity for continued investor protection. According to the
Wall Street Journal, non-traded REITs have raised more than $73 billion from investors over the past ten years – even in the face of the recession; and as a result, no amount of government scrutiny is likely to discourage investment promoters anytime soon. To understand why these investments are so attractive (and so ripe for fraudulent manipulation on the part of promoters), it is important to understand how they differ from their publicly traded counterparts – and what the U.S. Securities and Exchange Commission and FINRA are doing to protect investors moving into the New Year.
Investors have in recent years been inundated with solicitations to invest in various forms of “private” real estate ventures, such as private placement tenant in common (TIC) deals, non-traded REITs and other forms of passive real estate investment. The primary difference between public, exchange-traded REITs (a.k.a. “real estate stocks”) and private placements, non-traded REITs and the like is that shares of the latter do not trade on a national stock exchange. This makes the investments illiquid, limits early redemption of shares and allows for high initial fees that, in some cases, completely eclipse investor returns. In addition, it also makes it dangerously easy for dishonest investment promoters to take advantage of their clients due to diminished regulatory oversight of investment disclosures: indeed, one of the most common examples of non-traded REIT fraud involves the periodic distribution of investor principal under the guise of property generated income. While investors in publicly traded REITs can rest assured that the distributions they receive are in fact earnings generated from the activity of the real estate markets, those locked in to tricky non-traded REITs cannot. Subsequently, the SEC and FINRA have taken increased action against non-traded REIT promoters and brokers and issued warnings relating to real estate investment fraud in the interest of investor protection.
Private placement real estate and non-traded REIT investors bewareYet despite these warnings and the many disadvantages of locking one’s self into a non-traded REIT investment, individuals are nevertheless taking the risk. Why? One reason is that such investments tend to have higher advertised dividend yields than do traditional REITs – and in today’s troubled economy, the desire for income drives many investors to go beyond the bounds of the public market. When presented in this light, private placements and non-traded REITs may seem like appealing options; but as long as promoters continue to make misleading claims concerning returns and take advantage of the limited transparency of their operations, investors should keep the following SEC-recommended guidelines in mind when discussing the purchase of private placements and non-traded REIT shares:
- Make sure there is a balanced discussion of both risk and reward
- Compare whether or not the sales materials presented are consistent with representations in the prospectus
- Request information regarding the frequency and sources of distributions, as well as whether or not earnings from property operations will be sufficient to cover advertised dividends.
- Ask for details and ownership confirmation of properties, and request information about redemption programs, use of market performance data and the pros and cons of non-traded investments.
Corporate Finance Disclosure Guidance reportfrom the SEC, all promoters involved in the sale of non-traded REIT shares are required to provide this information. Therefore, if they fail or refuse to do so, those promoters are operating in a misleading manner that significantly raises the investor’s risk for fraud victimization. As seasoned
San Diego investment attorneys, we at the firm of Miller & Milove recommend that investors stay away from unduly risky investments, and use SEC and FINRA resources to ensure safe, transparent investment activity at all times. For further information concerning investor protection and fraud prevention, visit us online at