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Regulation and Compliance > Federal Regulation > DOL

A Nontraded REIT Product for the Post-DOL Fiduciary Era

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Advisors interested in investing client funds in nontraded REITs will still be able to so under the Department of Labor’s new fiduciary rule, but the disclosure required by that rule and a new rule from the Financial Industry Regulatory Authority will make it harder to do and possibly more risky.

In both cases, advisors will have to disclose more information about those securities than ever before. Under the DOL rule, compensation received by advisors and other costs associated with nontraded REITs must be disclosed. According to the Securities and Exchange Commission, upfront fees to compensate a firm or individual selling nontraded REITs can run as high as 15% of the offering price, and transaction costs to acquire and manage properties can also be significant.

Under the new FINRA rule, broker-dealers have to include the true value of nontraded REITs on customer account statements, not the par value as has been the case. They can use the net investment method which deducts sales commissions and other charges such as offering costs or, in the case of mid- to late life-cycle nontraded REITs, an appraisal of the estimated net asset value by a third party.

Both rules will likely reduce the demand for these products and, as a result, shrink the liquidity of these investments, which were already not very liquid.

Referring to the impact of the DOL fiduciary rule on nontraded REITs, Matt Sommer, director of Defined Contribution and Wealth Advisor Services at Janus Capital, says, “Firms will have to decide whether they are appropriate for IRA clients and even made available on their platforms. While the [Best Interest Contract Exemption] will permit the sale of these products as currently constructed, the best interest standard must still be met [and] with increased disclosure regarding fees, clients might be inclined to ask their advisors about alternative investment opportunities that provide a competitive yield but at a lower cost.”

The DOL and FINRA rules “will make the distribution of nontraded REITs through traditional broker channels much more difficult,” writes Mitch Wasterlain, co-CEO of CapitalFund Realty, a New York-based online real estate marketplace. Given the typical 15% fee on nontraded REITs, which would reduce a $10,000 investment to $8,500 right after shares are purchased, “a lot of investors are going to be very surprised to see that $1,500 has disappeared from their accounts,” Wasterlain says. In addition, says Wasterlain, the “requirement for advisors to put their clients’ best interest first … will [make it] … extremely difficult to sell a nontraded REIT to a retirement account.”

Against this background of changing regulations for nontraded REITs – a market which, at $10 billion in assets, is already half the size it was in 2013 – CAPFUNDR is offering the first of several closed-end funds consisting of these REITs that accredited individual investors and advisors can access through its online platform. There are no commissions or upfront fees.

The first fund, called CAPFUNDR REIT Value Fund 1, will close at $5 million and invest in nontraded REITs available in the secondary market for a significant discount, typically at between $0.20 and $0.50 on the dollar, and trading at a discount to NAV of 20% or more, Wasterlain tells ThinkAdvisor. The minimum investment is $10,000. The current annual return is an estimated 4% to 5% (from dividends) and the projected annual return, after liquidation or conversion to a public company, is 13.5% annually.

The fund is a buy-and-hold strategy for “anyone who wants to diversify with real estate, is interested in current income and appreciation and doesn’t require liquidity for five years or so,” says Wasterlain.

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