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Real Estate Investment Trusts
“REITs” are popular investment vehicles for those seeking to invest in real estate. REITs are companies, trusts, or associations that acquire income producing real estate, such as hotels, office buildings, or apartment building complexes. REITs are comparable to mutual funds in enabling both small and large investors to participate in the real estate market. They trade on major exchanges and are very liquid. They may provide tax benefits and typically provide favorable dividend yields. A REIT generally owns and manages the income producing real estate and can be listed publicly or privately.
Private, non-traded REITs do not trade on national securities exchanges and have certain investment features that make them appropriate for investors with an aggressive risk tolerance. This is due to a number of features unique to private non-traded REITs. Their upfront fees are very high. Non-traded REITs have sales commissions and offering fees that may add up to 15% of the offering proceeds. Since they are not listed on any exchange, they are very illiquid, making them difficult to sell in and out of. For investors with limited cash on hand who may need to sell in a bind, this would result in a very difficult situation. While certain non-traded REITs carry repurchase, sections contained within the offering’s prospectus, this is not always the case. These REITS are suitable for long term investors and are intended to be held for eight years or longer. Early redemption of non-traded REITs is often very limited. Such redemptions, if they occur, are substantially below the purchase price. Returns paid on these products can be subsidized by borrowed money and can also include return of principal. Non-traded REITs provide investors with distributions, not just from earnings on the properties managed and owned, but also from investor capital. Investors who are not sophisticated believe they are seeing a high yield or rate of return when, in reality, they are merely seeing returned investor capital, which may result in a lower return on the investment that must be repaid later.
Some REITs marketed by broker dealers must be registered with the New Jersey Bureau of Securities and can only be sold on the condition of heightened suitability standards. These “New Jersey Prospectus Suitability Standards” must be disclosed in the REITs prospectus and subscription agreement. The New Jersey Prospectus Suitability Standards restrict the sale of non-traded REITs to investors with a certain investment profile. The investor has to have a certain combination of income and net worth. The broker dealer would also have to calculate the total percentage of alternate investments being held by the investor, in addition to the non-traded REIT in relation to the investor’s liquid net worth. An investor’s liquid net worth is an investor’s assets, excluding house and car, and deducted from total liabilities.
Because of the illiquid market, firms often priced them on monthly account statements at their purchase price, no matter what their actual value may have been. Last year, FINRA changed its rules to specifically require firms to go through a process to more accurately report the current value of non-traded REITs on account statements. They must also provide more transparency on the high front-end fees charged for these products.
In 2018, Ameriprise Financial entered into a consent order with the Bureau of Securities in the State of New Jersey in connection with the marketing and sale of REITs to New Jersey investors. The consent order found that Ameriprise violated their own written supervisory procedures and failed to supervise brokers who were marketing REITs. Ameriprise’s supervisory procedures, in connection with the New Jersey Prospectus Suitability Standards discussed above, required that “State laws prohibit customers in some states from investing in excess of 10 percent of their net worth or liquid net worth in REITs or BDCs. Ameriprise Financial will not make exceptions to state laws.”
The New Jersey Bureau of Securities found that Ameriprise investment advisors marketed non-traded REITS in direct violation of the New Jersey Prospectus Suitability Standards and Ameriprise internal policy, with no pushback from the broker dealer’s branch managers. The New Jersey Bureau of Securities concluded that Ameriprise’s failure to supervise its brokers resulted in investors purchasing non-traded REITs in violation of the New Jersey Prospectus Suitability Requirements. According to the consent order the Bureau held that this constituted a failure to reasonably supervise pursuant to N.J.S.A. 49:3-58(a)(2)(xi). As a result, Ameriprise was ordered to pay a civil monetary penalty of $375,000 in connection with the marketing of the non-traded REITs.
In short, an investor should think long and hard before they invest in a non-traded REIT. They are complex and illiquid investment products that are appropriate only for aggressive and sophisticated investors.
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