A real estate investment trust (“REIT”) is a company or trust that owns – and typically operates – income producing real estate. REITs allow individual investors to have exposure to shopping centers, hotels, office buildings and warehouses. REITs can either be listed companies – which trade on an exchange – or “non-traded” (either private placements or registered, but non-listed, startups). Non-traded REITs (as opposed to listed REITs) have attracted significant attention from securities regulators due to their great potential for abuse.
One of the biggest problems with non-traded REITs is a lack of liquidity. Non-traded REITs are a long-term investment – typically 7 or more years. Except for the unlikely possibility of shares being repurchased by the REIT itself, there is no market for such shares. Investors must wait for a “liquidity event” – i.e. the sale of the REIT’s assets to another party or for the REIT’s IPO. Because of this extreme illiquidity, securities regulators have warned that ”Non-traded REITs are rarely, if ever, suitable for short-term investors and even long term investors must be willing to bear the risk of illiquidity”. See FINRA Investor Alert on REITs.
Non-traded REITs have many other potential problems. While they may be marketed as offering high dividends and stable values, both of these attributes can be wholly illusory. A REIT’s high dividend is not guaranteed and can stop at any time. Moreover, many REITs fund their dividends with borrowed money or with the very money they raised from their own investors (i.e. with returns of capital) because cash flows, especially in early years, are insufficient to pay dividends through actual earnings. REITs’ supposedly stable values can also be misleading. Brokerage firms typically report the REIT’s initial sale price as its value on monthly statements for an extended period of time. This ignores the fact that sales and organization costs can eat up to 15% of the money raised, meaning in such a case that from the outset the REIT is worth 85% of its initial sales price. In addition, the financial advisors who sell non-traded REITs typically receive very high commissions which creates incentives for investment fraud and abuse. Finally, REITs can be rife with self-dealing, creating conflicts between the interests of the REIT issuer/operator and its investors.
The very fact that your financial advisor has recommended a non-traded REIT is a red flag that he/she may not be putting your interests first. If you are stuck in a non-traded REIT due to the fraud or omissions of your financial advisor, contact the attorneys at PCJ Law at 901-820-4433 for a free, informative consultation to see if we can help.