Shortly after Susan Fox bought a nontraded real estate investment trust for her IRA, the REIT started to show quarterly losses. But when she met with her broker to discuss her concern, he sold her a second nontraded REIT.
The first REIT, Inland American Real Estate Trust, has fallen in value in the last five years from $10 per share to $7.22 per share, a 28% decline. Last month, Ms. Fox, 63, was informed that the second, Cornerstone Core Properties REIT Inc., had been devalued to $2.25 per share, from $8, a drop of 72%.
Ms. Fox claims that after watching the first REIT's performance decline, she never intended to buy the second one.
Ms. Fox, who was living in Plano, Texas, when she bought the REITs and now resides in Ramsey, Ill., sensed trouble in the summer of 2008 when the Inland REIT started to post losses. So she and her broker, John Potts, met at her home to discuss what to do with her IRA. During their conversation, Mr. Potts was squarely focused on the Cornerstone REIT, Ms. Fox said.
“I was concerned with Inland performing so poorly, and he sold me Cornerstone,” said Ms. Fox, who claims she did not know the investments were illiquid when she bought them.
"TALKING OVER MY HEAD'
“My recollection was that he deflected talking about Inland,” she said. “He was talking over my head and said that [Cornerstone] was a better investment with a better, reputable company, and it would pay dividends. He had a lot of paper spread out on the table. He had all the documents ready for me to sign, and I signed them.”
She knew Mr. Potts and had worked for him, doing some bookkeeping for his firm, Signature Planning Inc., and was “impressed with his due diligence,” she said.
During the real estate boom, such REITs were regularly touted as being stable, long-term investments because they invested in commercial real estate, which historically had performed well as an asset class. As some REITs' values have plunged the opposite has proved true.
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The REIT industry often puts the blame squarely on the real estate bubble rather than on any individual real estate investing strategy.
For example, Cornerstone in a letter to investors last month said: “The estimated per-share value has been adversely affected by the recent global economic downturn, negatively impacting our small-business tenant base, which has resulted in approximately $43 million of previously announced impairment charges recorded in the second and third quarters of 2011.” The letter was signed by Terry Roussel, the REIT's chairman and chief executive, who did not return calls seeking comment.
ALARMED ABOUT IRA
Adding to Ms. Fox's predicament, the REITs were part of her IRA, which in 2008 had $105,000 in it. The REITs accounted for $56,616 of the account, or almost 54%.
Having such a large percentage of her IRA in illiquid investments alarmed Ms. Fox, and in July 2010, she told her broker to sell the investments. When he told her she was stuck, she began to complain.
“I purport that I was overallocated to nonliquid investments unsuitable for my short-time-horizon needs,” she wrote in a letter in July 2010 to Thomas Berthel, CEO and owner of Berthel Fisher & Co. Financial Services Inc., an independent broker-dealer that employed Mr. Potts.
In 2010, Ms. Fox also complained to the Financial Industry Regulatory Authority Inc., which looked into the matter but took no action.
Mr. Potts, the broker, did not return phone calls seeking comment.
A Berthel Fisher spokeswoman, Shelli Brady, wrote in an e-mail : “We take all customer concerns very seriously and we did investigate Ms. Fox's concerns.”
Ms. Brady said the firm concluded that Mr. Potts acted appropriately and that there were no sales practice problems with Ms. Fox's transactions. “We remain confident that the sales practices of our registered representative were appropriate,” Ms. Brady wrote.
One question from Ms. Fox's dilemma is the appropriateness of investing in illiquid instruments in retirement accounts.
The direct-participation-program industry, which includes nontraded REITs and other investments, is trying to make the REITs more palatable for investors, including those with retirement accounts, by creating products that have daily net asset values and increased liquidity, industry observers said.
Most nontraded REITs are given a value only once a year, and that is after they finish their period of sales. Securities regulators recently have proposed rules that would tighten up the time for valuations.
“There's confusion in people's minds between the extent of an investment being liquid and safe,” said Tony Webb, a research economist with the Center for Retirement Research at Boston College. “A five-year [certificate of deposit] is not liquid but safe. A publicly traded share is liquid but not safe.”
“Clearly, in the face of the uncertainty of health care costs, households place a certain value on liquidity, but it's not important that all the household's wealth is liquid,” Mr. Webb said.
“This is one where the adviser should be faulted, not that the investment wasn't liquid but that the level of risk wasn't appropriate for the client,” he said. “I don't know the client's financial situation, but it strikes me, at first glance, of being an inappropriate investment.”
While no figures are available for the overall percentage of illiquid investments in retirement accounts, industry executives said they are widely sold.
At independent broker-dealers such as Berthel Fisher, two of the most popular types of illiquid investments are nontraded REITs and the more recently developed nontraded business development companies, or BDCs.
Such investments yield income, which is appealing for the long-term investor, said Kevin Hogan, president of The Investment Program Association, an industry association for the broker-dealers that market and sell such investments.
“Most IRA accounts run for 10 to 20 years, and that fits the long-term nature of nonlisted REITs,” he said. “I think you'll see more nonlisted REITs in IRAs because of income and distribution potential.”