GIVEN THE BARRAGE of negative publicity surrounding nontraded real estate investment trusts, broker-dealers and REIT sponsors have a vested interest in working closely with regulators to improve investors'
understanding of the value and performance of nontraded REITs.
If they don't, they're likely to find themselves saddled with regulations that are cumbersome, costly and, most importantly, even more confusing than those that exist today.
Broker-dealers and REIT sponsors need to step up their efforts to develop industry-accepted standards for formulating asset valuations and to hold brokers more accountable for making sure nontraded REITs are suitable for the clients to whom they are recommending them.
RISKY FOR SENIORS
Regulators are right to set their sights on the nontraded-REIT industry. As sales of nontraded REITs have grown — no doubt thanks to the volatility of the stock markets and the low-interest-rate environment — so, too, has the number of investors, many of them seniors, who have found themselves blindsided by plunging share values or inadequate disclosure related to the illiquidity of their investments.
In an article appearing last week in InvestmentNews, news editor Bruce Kelly profiled the plight of investor Susan Fox, who watched the value of nontraded-REIT shares in her IRA plummet. One of those REITs — Cornerstone Core Properties REIT Inc. — recently disclosed that its share value had dropped 72% to $2.25, from $8. In the story, Ms. Fox, 63, alleged that her broker invested too much of her retirement savings in nontraded REITs and that she was not made aware of the inherent illiquidity of those shares.
Ms. Fox is hardly alone. Last May, the Financial Industry Regulatory Authority Inc. accused David Lerner Associates Inc. of selling shares of its real estate funds to elderly and unsophisticated clients.
Clearly, more regulation is warranted. On March 7, Finra issued a revised proposal to amend NASD Rule 2340 to address the “per-share estimated values” at which unlisted direct-participation programs, including nontraded REITs, are reported on customer account statements.
Under the revised proposal, broker-dealers no longer would be required to provide investors with a per-share estimated value, unless and until the issuer provided an appraised value of the shares in a periodic report filed under the Securities and Exchange Act of 1934. During a nontraded-REIT initial-offering period, broker-dealers would have the option of representing the security as “not priced” or presenting investors with a net offering price minus the broker's upfront commissions.
The public-comment period for that proposed rule change ends April 11. If enacted, the rule change would improve investor protection in two ways. First, it would shine light on the high upfront broker commissions for selling REITs. Those commissions, which often range from 10% to 15%, inevitably would fall — decreasing the incentive for brokers to sell unsuitable nontraded REITs.
Additionally, the rule change would help eliminate investor confusion about the value of REIT shares during their IPO period — and, in some instances, well beyond that.
In and of themselves, nontraded REITs are neither “good” nor “bad”; they're simply investment vehicles that are suited to some investors, but not to most.
