FINRA Issues Alert on Public Nontraded REITs

As FINRA explains, real estate investment trusts pool the capital of numerous investors to purchase a portfolio of properties—from office buildings to hotels and apartments, even timber-producing land—which the typical investor might not otherwise be able to purchase individually. There are two types of public REITs: those that trade on a national securities exchange and those that do not.

FINRA’s alert focuses on publicly registered nonexchange traded, or simply nontraded REITs.

The Public Non-Traded REITs alert outlines the features, complexities, risks and costs associated with nontraded REITs, which are as follows:

• Distributions are not guaranteed and may exceed operating cash flow. In newer programs, distributions may be funded in part or entirely by cash from investor capital or borrowings. Distributions can also be suspended for a period of time or halted altogether.
• Lack of a public trading market creates illiquidity and valuation complexities. Most nontraded REITs are structured as a “finite life investment,” meaning that at the end of a given timeframe, the REIT is required either to list on a national securities exchange or liquidate. Many factors affect the valuation of nontraded REITs, including the portfolio of real estate assets owned, strength of the trust’s balance sheet, overhead expenses and cost of capital.
• Early redemption is often restrictive and may be expensive. Most non-traded REITs place limits on the amount of shares that can be redeemed prior to liquidation. These limits can be as restrictive as 5—or even 3—percent of the weighted average number of shares outstanding during the previous year. Additionally, the redemption price is generally lower than the purchase price, sometimes by as much as 10 percent.
• Nontraded REITs can be expensive. State and FINRA guidelines limit front-end fees to 15 percent, but a 15-percent front-end fee on a $10,000 investment means that only $8,500 is going to work for an investor.

The alert also warns investors about private REITs—generally sold only to accredited investors—which not only do not trade on an exchange, but also are generally exempt from Securities Act registration. FINRA cautions that it is extremely difficult for investors to make an informed decision about private REITs due to their lack of disclosure documents.