As sponsors of nontraded real estate investment trusts continue their full-court press on sales, some independent broker-dealers are dialing back their level of risk and have cut back, or are considering reducing, the number of REIT products they allow their representatives to sell.
The cutbacks are being made even though sponsors of nontraded REITs reported strong sales through the first six months of 2011. According to consultants who follow the marketplace, investors bought close to $4.6 billion in nontraded REITs through June 30. That put sales on a pace to top 2010's full-year total of about $8.4 billion — the third highest ever, according to Direct Investments Spectrum, a newsletter that follows the nontraded-REIT marketplace.
In the face of a sales boom, some executives with independent broker-dealers are being more selective in what they allow their affiliated reps and advisers to sell. Their concerns focus on the REITs' expenses and how the REITs pay for their dividend, or “distribution,” as it is known in the industry.
In May, the Financial Industry Regulatory Authority Inc. drew attention to the issue of nontraded-REIT distributions when it filed a complaint against David Lerner Associates Inc. In that complaint, Finra alleged that a series of REITs sold by the firm, known as the Apple REITs, maintained “outsized distributions of 7% to 8% by leveraging the REITs through borrowings and returning capital to investors.”
The firm has called the charges in the Finra complaint “baseless.”
National Planning Holdings Inc., a network of four broker-dealers with 3,663 affiliated reps and advisers, this year cut the number of nontraded REITs on its platform to 10, from 15.
And Next Financial Group Inc., which has 923 affiliated reps and advisers, cut the number of products to five, from seven. Two years ago, the firm offered twice as many nontraded REITs for its reps to sell.
Meanwhile, two other brokerage executives, who asked not to be identified, indicated that a number of firms have reduced the number of nontraded REITs available for brokers to sell, or are planning to do so.
For Next Financial, the main concern about certain nontraded REITs is their expenses and how they pay their dividend, said Barry Knight, the firm's chief executive.
“We did not set out to prune back the list,” he said. “We look at every offering with the same screens, but approval standards have increased on all products as a result of what's gone on in the marketplace, and the result of increased potential risk out there for clients and firms.” Mr. Knight declined to name the specific REITs cut from Next Financial's roster.
“In doing that assessment, fewer products have passed those screens,” he said. “If more products met our screens, the list would be bigger. We're not looking to limit the list [of nontraded REITs] to X number of providers, but we have a stringent process for approval.”
Andrew Silver, a spokesman for the National Planning Holdings broker-dealers — National Planning Corp., Invest Financial Corp., Investment Centers of America Inc. and SII Investments Inc. — said that the decision to suspend five REIT offerings was made this year as a result of normal due diligence. He declined to name the five suspended REITs.
SALES PUSH IS ON
Meanwhile, more nontraded-REIT sponsors than ever are knocking on the doors of broker-dealers. According to consulting firm Blue Vault Partners LLC, 68 nontraded REITs are now on the market, a new industry high.
“The cutbacks [by broker-dealers] don't surprise me,” said Stacey Chitty, a partner with Blue Vault. “Firms are reducing risk and the workload. If a broker-dealer has a REIT on the shelf that's not raising any money, it still has the same workload. The question for the firm is, "Why am I selling this?'”
Mr. Chitty noted that the nontraded-REIT industry is top-heavy, with the 10 leading sponsors raising about 80% of the money in the market. That makes it more difficult for new nontraded REITs to get a foothold. “Firms are not cutting any REITs that raise significant money,” Mr. Chitty said. “All the broker-dealers are trying to do is to reduce risk.”
In a crowded market, some REIT sponsors will struggle to raise enough capital from investors, said Spencer Jefferies, editor of Direct Investments Spectrum.
“As a broker-dealer, you've got to be really worried if your [REIT] sponsor is not raising much money,” he said. “If you're not raising capital, you can't fund property acquisitions or get meaningful diversification. Running a publicly registered company is expensive, and you need a good asset base to drive that.”
Email Bruce Kelly at [email protected]
