Editorial

Brokers' job to explain nontraded REITs

Feb 9, 2014 @ 12:01 am

Finra last week took welcome steps to shed much-needed light on nontraded REITs. But, quite frankly, the changes being proposed should be information already being conveyed to investors by their brokers.

Nontraded real estate investment trusts have exploded in popularity in the past few years as investors have flocked to financial products that offer higher returns than they could get in traditional fixed-income investments.

Last year, $20 billion in nontraded REITs were sold, compared with $10.3 billion the year before. A like number of shares — or more — are expected to be sold this year.

Amid low interest rates, nontraded REITS can be a good choice for many investors, at least for a portion of their portfolios, provided they fully understand how the investments work and how much it costs to purchase them.

And there is the rub.

Until now, the nontraded-REIT market has rightfully been described as “murky” and “opaque.” Investor advocates have talked about “hidden fees” and “valuation problems.”

Under current rules, brokers can list the per-share value of nontraded REITs at $10 a share, the price at which they are usually sold, for up to 18 months after the sponsor stops raising funds, even though commissions and fees that can total up to 12% of the share price have already been deducted. Given that it can take two to three years to raise funds for a nonlisted REIT, that means investors could be receiving inflated valuations for al-most five years after they initally invest.

The proposed changes being sent by the Financial Industry Regulatory Authority Inc. to the Securities and Exchange Commission for final approval would mean true valuations sooner for investors.

Under one of the valuation methods, brokers would have to reflect commissions and fees on statements as soon as a nontraded REIT was permitted to access the offering proceeds to buy real estate. REIT sponsors would be allowed to use that valuation for a period of two years.

A second valuation method would entail getting a third-party expert to sign off on a REIT's valuation.

INDUSTRY WORRY

The broker-dealer industry has a lot at stake regarding these new rules. Many had record revenue from nontraded-REIT sales last year, and they are worried that the new rules could hurt future sales if investors are seeing account statements that explicitly show the fees and commissions being charged for these investments.

But it should be the responsibility of every broker selling these products — even without the new rules — to make sure their clients understand how the products work and how much they cost.

For example, brokers need to have an honest discussion about illiquidity and the fact that the money invested in a nontraded REIT may not be available for a three-to five-year period. And new Finra rules notwithstanding, brokers should remind their clients that the value of their investments may actually be lower at times than their statements indicate.

In the end, nontraded REITS, like every investment, have to stand on their own merit.

0
Comments

What do you think?

View comments

Recommended for you

Featured video

Events

What top advisers are doing to stay ahead of the curve

Top advisers understand that they need to work outside the box and focus on generational reach. Susan Kay of MFS Fund Distributors, Inc. explains.

Latest news & opinion

DOL fiduciary rule opponents want to push implementation back until 2019

ICI, Chamber of Commerce among groups asking for delay, while Democratic lawmakers call on DOL to keep to its earlier planned schedule of Jan. 1, 2018.

Take 5: Vanguard's new CIO Greg Davis talks bonds, stocks and costs

Having just stepped into the role, this veteran of the firm now oversees $3.8 trillion in assets in more than 300 mutual funds and exchange-traded funds.

Tech companies deploy behavioral finance tools for advisers

They seek to turn knowing more about clients into growing more revenue.

Retirement planning for women

Longer lifespans and lower savings require creative income strategies.

Sean Spicer resigns as press secretary after Anthony Scaramucci is appointed communications director

Scaramucci is known as an ardent foe of the DOL fiduciary rule, having said during the campaign that Trump would repeal it .

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print