An eye-opening analysis of the “distributions” of nontraded REITs sold exclusively by David Lerner Associates Inc. shows the
REIT's property investments largely underperformed the level required to pay promised dividends to investors. Indeed, the analysis claims that the REITs consistently borrowed from a line of credit and used distributions investors were recycling back into the real estate investment
trust to meet the targeted
dividend payout.
The examination of the REITs sold by David Lerner brokers, known as Apple REITs, is included in an amended complaint of a prospective class action filed by investors this week in federal court in Newark, N.J.
The original class action was filed in June, weeks after the
Financial Industry Regulatory Authority Inc. sued David Lerner Associates, a broker-dealer based in Syosset, N.Y., for misleading investors. The firm allegedly provided misleading performance figures for Apple REITs and implied that future investments could be expected to achieve similar results, according to Finra.
According to the amended class action complaint, the distribution paid to investors did not match the level of income generated from the various Apple REITs, which invested primarily in Marriott and Hilton extended-stay hotels. Brokers at David Lerner allegedly told clients that the Apple REITs were safe conservative investments that would protect their savings from the volatility of the stock market. The suit says investors were promised steady, annualized returns in the neighborhood of 7% to 8%.
According to the complaint, David Lerner represented that distributions would be made based on cash flow. Offering documents, however, stated that paying distributions from other sources could happen only in “certain circumstances” and “from time to time.” For example, Apple
REIT Eight paid $238.2 million in distributions to investors from 2007 to 2010, with only $82.3 million — or 34% — coming from cash from the
REIT's operations, according to the complaint.
Likewise, Apple
REIT Nine from 2008 to 2010 paid $188.5 million in distributions, with $42.2 million — or 22% — derived from cash from operations.
David Lerner Associates and other defendants “paid distributions without regard to profitability, even as they acquired properties at prices they knew could not conceivably justify the level of distributions they were paying,” the complaint alleges.
Paying for a nontraded
REIT's distribution with cash from operations has become one of the most closely watched measuring points for a
REIT product, industry executives have recently said.
“David Lerner Associates vehemently denies all allegations,” Joseph C. Pickard, senior vice president and general counsel, in a statement. “It would be inappropriate to comment further because this is pending litigation.”
“We studied the David Lerner REITs in great detail and have consulted with
REIT and hotel experts, and laid out a case in great detail for the court and David Lerner, Apple
REIT shareholders,” said Jake Zamansky, a plaintiff's attorney in New York. “It's a stark and starling presentation of this very dubious investment.”
All told, investors bought $5.7 billion in five separate Apple offerings from David Lerner brokers from 2004 to 2010, according to the class action complaint, with the REITs valued at $11 per share. The most damning allegation in the lawsuit, which is waiting for approval of class action status, is that David Lerner negligently misrepresented to investors the value of $11 per share for the Apple REITs, Mr. Zamansky said. “That was not accurate, and the financial operations of borrowing and financing through new purchasers were never disclosed.”
Lead plaintiffs include Stanley and Debra Kronberg of Mahwah, N.J., who invested $420,000 in various Apple REITs.
David Lerner Associates, which is the lead defendant the lawsuit, did not create or manage the REITs, but no other broker-dealer sold the product. The Apple REITs are controlled and managed by Glade Knight, a real estate investor based in Richmond, Va., who is also named in the lawsuit.
David Lerner and its brokers have received $341.5 million in commissions and expenses from the sale of Apple REITs Eight, Nine and Ten, according to the complaint. The firm and brokers receive a 7.5% commission from each Apple
REIT share it sells, along with a 2.5% marketing expense, according to the complaint.
On client brokerage account statements, David Lerner no longer lists the Apple
REIT shares at $11 per unit but now describes them as “not priced,” according to the class action complaint.
