Re-pricing nontraded REITs: A thorny issue for broker-dealers

Finra is paying close attention to nontraded REITs

Jun 5, 2011 @ 12:01 am

By Bruce Kelly

Independent broker-dealers and their representatives are contending with the potentially thorny issue of re-pricing shares of nontraded REITs — illiquid, long-term investments in commercial real estate.

Before 2009, the common practice in the brokerage industry was to list the share price on client account statements at par value, or the amount at which the broker-dealer sold it, with the product typically priced at $10 a share.

That has changed, with some nontraded real estate investment trusts now reporting significantly lower share prices than in the past.

That is because in 2009, the Financial Industry Regulatory Authority Inc. told broker-dealers that they needed to adjust the prices on the investments more frequently. In a notice to members, Finra said that it was prohibiting broker-dealers from using information that was more than 18 months old to estimate the value of a nontraded REIT.

The value of many REITs has declined in the past few years, not only because of declining real estate values but because some REITs have resorted to tapping principal and even borrowed funds to maintain their dividend payments to investors.

Finra clearly is paying close attention to the share price of non-traded REITs.

Last week, in a complaint that it filed against David Lerner Associates Inc., the regulator, among other charges, voiced concern over the fact that the firm had marketed shares in Apple REITs that hadn't been re-priced for several years. Since 1992, David Lerner Associates had recommended and sold nearly $6.8 billion in Apple REIT shares, according to Finra.

It was misleading to investors not to reflect the updated value of the REITs on David Lerner Associates' website, especially in those cases where the REITs were paying dividends with principal and borrowed funds instead of operating income, Finra said.

“Earlier Apple REITs, under the same management, inappropriately valued the REIT shares at a constant artificial price of $11, notwithstanding years of market fluctuations, performance declines, increased leverage and excessive return of capital to investors,” Finra said in its complaint.

In a statement, David Lerner Associates said that it “vehemently denies” Finra's charges, including any alleged “valuation and distribution irregularities.” The firm said that it looks forward to the opportunity “to set the record straight and expects to be completely vindicated.”

The changes in the share price of some other funds have been notable.

Hines Real Estate Investment Trust Inc. said in a statement last month that as of the end of March, it valued its shares at $7.78, down from its original $10 valuation. In May of last year, Behringer Harvard REIT I Inc. was re-priced at $4.25 per share, also down from its initial $10. In January, the REIT revised its share price up by 30 cents.

Meanwhile, other nontraded REITs are expected to re-price this year.

For example, Wells REIT II, which finished its offering last June and has $5.95 billion in total assets, is scheduled to have a new price at the end of the year, according to Finra's timetable.


The new prices of nontraded REITs take into account not only the underlying value of the fund's real estate assets, but also slice off the representative's commission, typically 6% to 8%, and other distribution costs.

Some broker-dealer executives and REIT analysts played down the ultimate impact of re-pricing, saying reps and clients are realistic in their expectations for commercial real estate in the wake of the credit crisis. Others, however, noted that the new share prices of the nontraded REITs will cause uncomfortable discussions between reps and clients.

Pricing and a client's desire to sell an investment are intertwined, noted Brian Kovack, president of Kovack Securities Inc., a midsize independent broker-dealer with about 300 producing reps and advisers. “Pricing drives the need for liquidity because when the value of the share declines, the client wants out,” he said.

Since nontraded REITs are illiquid, clients typically are stuck with the product, generally for at least five years. REIT sponsors buy back a limited number of shares each year, and a thinly traded secondary market exists where investors can sell shares at a steep discount.

Kovack Securities recommends that clients' exposure be capped at 5% of the portfolio, but some instances will increase the amount to 10%. That may change, he said.

“Senior management at Kovack is actively re-examining limiting exposure to nonpublicly traded REITs,” he said.

“The performance of the product is fabulous,” he said. “The bigger question is: How much of an illiquid investment should be in a client's portfolio?”

Real estate, by its nature, is an illiquid and long-term investment, noted others who downplayed the effect of re-pricing on clients' portfolios. One option to keep a client's allocation to real estate in line after a nontraded REIT is re-priced is for the investor to buy publicly traded REITs that offer liquidity, said Keith Allaire, managing director of Robert A. Stanger & Co., an investment banking firm specializing in real estate. “The virtue and curse of nontraded real estate” is that it doesn't allow investors to move in and out of the security, he said.

The popularity of nontraded REITs is due to their relatively high yield in the current low-yield environment, he noted. “Yields of 6% to 8% are much more substantial than current interest rates,” he said.

E-mail Bruce Kelly at


COMPLAINT: Finra says David Lerner Associates misled investors in marketing a non-traded REIT. Page 24


What do you think?

View comments

Recommended for you

Upcoming Event

Oct 09


Diversity & Inclusion Awards

Attend the industry’s first event celebrating diversity and inclusion as well as recognizing those who are leading the financial services profession in this important endeavor. Join InvestmentNews, as we strive to raise awareness, educate... Learn more

Featured video


Transamerica's Boan: Crafting better retirement income conversations

Retirement income is a challenge for investors. How can advisers have better conversations about retirement income? Transamerica's Joseph Boan offers insights and tips for advisers.

Latest news & opinion

As DOL fiduciary rule dies, variable annuities come alive — sales up for first time since 2014

Indexed annuity sales also broke their previous quarterly sales record.

Cambridge Investment Research bags mid-sized broker-dealer

Broker Dealer Financial Services, an IBD with 150 reps and advisers, and $3.5 billion in assets, will become a Cambridge OSJ.

HighTower on prowl for new CEO, Weissbluth to become chairman

Move is latest in Chicago-based RIA consolidator's effort to expand senior leadership team.

What's in a name? For TCA by ETrade, everything

Trust Company of America is gone, and there's big buzz over the name change. But turning the custodian into an industry powerhouse will take a lot longer — if it happens at all.

When it comes to regulating AI in financial services, murky waters are ahead

Laws are unclear on how the technology fits in with compliance.


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting It'll help us continue to serve you.

Yes, show me how to whitelist

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print