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What you should know before purchasing non-traded REITs

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A real estate investment trust, or “REIT,” is a trust/corporation that owns income-producing real estate. The trusts or corporations have to meet many requirements to qualify as REITs. REITs pool the money of many investors to purchase a portfolio of properties, to include shopping centers, strip malls, office buildings, apartments and hotel, which a typical investor might not otherwise be able to purchase individually. There are three (3) types of  REITs:

1) Those that trade on a national securities exchange.

2) Those that are not publicly traded but are registered with the SEC.

3) Private placement REITs. 

REITs in the first category trade on one of the national exchanges. REITs in second category are generally referred to as publicly registered non-exchange traded, or simply non-traded REITS. Those in the third category, are exempt from SEC registration and are typically offered to accredited investors via private-placement.   

Private REITs can present significant problems for the unwary investors who are looking for an income producing investment. Investments in private REITs lend themselves to significant sales practice violations as they do not have the same disclosure requirements as public REITs. The lack of disclosure documents makes it very difficult for investors to make an informed decision about the investment. Moreover, it is difficult to value these investments because they are typically not listed or traded.

The lack of sufficient discourse related to the sale of REITS, and sales practice issues, forced FINRA to release Regulatory Notice 15-02 Regulatory Notice 15-02Regulatory Notice 15-02 Regulatory Notice 15-02  in early 2015. In this Regulatory Notice 15-02, FINRA required member firms to disclose to investors a per share estimated value for the REIT using the “net investment methodology” and “appraised value methodology.” Financial advisors that sell non-traded REITs are also required to disclose that the securities are not listed on a securities exchange, that the securities are generally illiquid, and that, even if a customer is able to sell the securities, the price received may be less than the per share estimated value.

Financial advisors can receive significant and large front-end compensation for selling private REITs, thus driving them to place their interests before their client’s interests. Fees paid to financial advisors can range between 10% to 15% of the amount invested, depending on the circumstances related to the sale. We have seen cases where these large front-end fees are played down, or not properly disclosure to the investor. These investments also typically illiquid, which means you cannot sell your position in the REIT on the public market. If you are able to find a willing buyer, the sale price is typically well below the amounts invested. Non-traded REITs are rarely, if ever, suitable for short-term investors and even long-term investors must able to bear the risks of illiquidity. From time-to-time, a financial advisor will sell the non-traded REITs by comparing them to certificates of deposit. While a CD pays a regular and predictable income, CDs have a significantly lower risk given their liquidity and constant value.     

You should be suspicious of sales pitches that offer simplistic reasons to buy a REIT.  These pitches will typically play up potential high yields and stability while failing to disclose the product’s lack of liquidity, high front-end fees paid to the advisor and other risks. Make sure you ask whoever is recommending that you purchase a REIT how much they receiving by way of commission and/or other fees. You should also ask them to document for you, in writing, how the REIT will  help you achieve your specific investment objectives and goals. If you have already purchased a REIT and believe your financial advisor was not forthcoming about certain aspects of the investment, or if you believe you have been taken advantage of by way of purchasing this product, please contact our office and ask to speak with one of our lawyers.    

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