The REIT with a twist is a nontraded REIT packaged as preferred stock.
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.
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 the 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.
MahanyLaw – Stockbroker Fraud and Investment Recovery Lawyers