The REIT with a twist is a nontraded REIT packaged as preferred stock.
In the paragraphs below we discuss why stockbrokers love non-traded REITs, why you should be very wary and how they have become the canary in the coal mine for investors as the economy slows in the wake of the coronavirus pandemic.
What are Nontraded REITs?
A non-traded REIT is a form of real estate investment method that allows individual investors to invest in large real estate projects or portfolios. They offer the ability to reduce or eliminate tax while providing above market returns on real estate. Non-traded REITs do not trade on a securities exchange. That makes them illiquid and difficult to sell. a Front-end fees can be as much as 15%, much higher than a traded REIT due to the limited secondary market.
Types of REIT Investments
There are three types of REITs:
- Private REIT
- Public, Non-Traded REIT
- Public, Traded REIT
A Private REIT is not registered with the SEC. Because they are not listed or regulated, getting performance information is difficult. These investments are only available to accredited investors meaning folks who have $1 million in net worth or had income for the past two years in excess of $200,000.
A Public, Non-Traded REIT is a bit of a misnomer. By public, it means they are registered and regulated by the SEC although they are not available on a stock exchange. This post is primarily about non-traded REITs and their new derivatives.
A Public, Traded REIT is registered and regulated by the SEC and listed on a stock exchange. That means their value is a bit easier to determine although many are very thinly traded meaning listed values may not be accurate.
Non-traded REITs – A Bad Idea?
Nontraded REITs have come under scrutiny in recent years by the SEC, many state security regulators and the Financial Industry Regulatory Authority (FINRA). Although they may be a viable investment strategy for institutional investors, stockbrokers often sold them to elderly investors and those nearing retirement. The very people that need access to their funds suddenly found their shares couldn’t be liquidated. Investors sometimes must hold their shares for years before they can be liquidated.
Despite being bad for investors, stockbrokers love nontraded REITs because they pay huge commissions…. commissions that are often 7%. (Compare that with commissions on regular investments that are usually under 1%.) Brokers love them because they are easy to sell. With bank and treasury yields at historic lows, nontraded REITs claim high yields and monthly payments.
On paper, these products look great. Many brokers, however, didn’t properly educate their customers about the high commissions, high internal fees, low or no liquidity and high risk.
With nontraded REITs getting bad press, one promoter came up with a new scheme called “nontraded redeemable preferred shares.” John Williams launched Preferred Apartment Communities, a traditional non-traded REIT, in 2010. Shortly thereafter, Williams came up with a new scheme – a “twist” in the words of InvestmentNews – he offered preferred shares of stock in the REIT. For $1000, an investor gets one share of stock with a 6% yield and a warrant to buy 20 more shares of common stock.
Investors get their 6% yield for the next 5 years at which time they can redeem for the $1000 original purchase price. Williams offers a bit more liquidity by allowing early redemptions (but subject to an early redemption fee).
We worry that Williams may have become the victim of his own success. Preferred Apartment Communities has raised so much money that it may not be able to keep finding quality properties capable of generating the cash flow necessary to pay big dividends and big commissions too. Like other similar REIT products, these shares pay 7% commissions. 6% yield plus 7% commissions, plus broker dealer fees plus high internal costs… can Preferred Apartment generate enough cash flow?
Another one of the things that worries us is Preferred Apartment’s outside management. Typical of many nontraded REITs, outside management usually means high fees.
Yet another worry is the lack of transparency. FINRA enacted rules requiring disclosure of the commissions on traditional non traded REIT investments but Williams skirts those rules by structuring shares as preferred shares. There are plenty of traditional real estate investment trusts without the liquidity problems, high fees and with much better transparency.
Wall Street has a habit of developing new products simply as a way of circumventing rules and disclosure. That these new preferred shares skirt the new FINRA commission disclosure rules is a red flag for us.
Probably the biggest problem with these investments is how they are marketed. Brokers have a legal obligation to fully understand their customers’ needs and risk tolerance. (Know Your Customer or “KYC” rules) They also have an obligation to only make investment recommendations that are suitable for their clients (suitability rules). While most follow the rules, a few are more interested in finding investments that generate the most commissions. Non-traded REITs are at the top of the list.
The biggest benefit to investors is the ability to participate in large real estate projects. Typically an individual investors simply doesn’t have the funds to develop a shopping center, office park or high rise tower. As noted above, the lack of liquidity is the biggest drawback. You could be stuck in the investment for a decade before you have the ability to sell.
The Coronavirus Pandemic and REITs
Investors are easily sold on REITs because they make monthly or quarterly distributions that are typically much higher than you can get from a savings account or CD. The money for these distributions comes from the rents or mortgage payments from the properties in the REIT. Unless there is a REIT that just invested in grocery stores, many commercial properties are not generating rent.
Stores have no income. Shopping centers are empty (even in states where they were allowed to open). Hotels are empty. Amusement areas are closed. Student housing, a favorite in the REIT world, is empty. That means no money to distribute.
At this writing, the stock market is still performing strongly. Commercial real estate is a dumpster fire, however and that means many REITs are in trouble.
If you bough a publicly traded REIT, it might not be worth as much but you can liquidate your investment if you need money. Folks invested in nontraded REITs are in trouble.
This morning we heard from a 61 year old investor who invested $105,000 in a nontraded REIT. He purchased through a broker. Last month he lost his job as the result of the coronavirus. He worries that at his age he won’t easily find another job, especially with millions of other Americans also looking for work.
After calling his broker he learned that his investment is now worth $70,000. When he asked to liquidate it so he can pay bills and feed his family, the news got worth. Not only did his investment drop by over $30,000 in value, he can’t liquidate it. That particular REIT limits him to no more than $5,000 per year in liquidation.
That begs the question, is his investment really worth even $70,000 if he can’t sell it? Unfortunately, as millions of middle class Americans are trying to survive, we think thousands of those folks that invested in nontraded REITs will face a similar harsh reality.
The brokers peddling these investments had an obligation to understand their customers needs and to only make suitable recommendations. Nontraded Real Estate Investment Trusts aren’t suitable for anyone needing access to their money.
I Bought Non-Traded REITs and Lost my Money, Now What?
Both traded and non-traded REIT investments are typically sold by stockbrokers. They love them because of the huge commissions. Unfortunately, they are not suitable for many individual investors. Stockbrokers and the brokerage firms that employ them are responsible for losses when the broker fails to understand his or her customer’s needs, fails to properly explain the risks of the investment or makes an unsuitable investment recommendation.
MahanyLaw and Non-traded REITs
The fraud recovery lawyers at MahanyLaw understand illiquid investments and how to recover our clients’ hard earned money. Most investment loss cases are handled on a contingent fee basis meaning you don’t owe us anything unless we recover money for you. Our consultations are always no fee and no obligation.
For more information, please visit our investor and fraud recovery page. Ready to see if you have a case? Contact attorney Brian Mahany online, by email at or by telephone at (202) 800-9791. Cases accepted nationwide.
MahanyLaw – Stockbroker Fraud and Investment Recovery Lawyers