Non-traded REITs, also called non-listed REITs, continue to be pushed and marketed by brokers across the United States as attractive, low-risk investments tailored for people who want to avoid market volatility while gaining an alternative source of income. But not only are these products packed with obscene fees and commissions, unfortunately they are also burdened with managers who have conflicts of interest that oftentimes lead them to make decisions that are not in the best interests of investors.
Before investors decide to buy into any of these highly illiquid investments, we believe they ought to ask these five due diligence questions:
1. What are the REIT’s upfront fees, and what other fees will be charged throughout the life of the REIT? In other words, determine exactly how much of your money will actually go towards investing in real estate and how much goes into the pockets of the REIT managers.
Most non-traded REITs charge a substantial commission, which is directly passed on to the broker who sold the non-traded REIT, causing many brokers to push these products very aggressively. In most cases, brokers receive between seven and nine percent of the total investment amount.
In addition, many non-traded REITs charge on-going fees of approximately 3 percent of the REIT’s entire earnings. It is important to understand that all these fees are, for the most part, charged by parent companies and/or subsidiaries, meaning that all monies end up in the pockets of the REIT owners.
2. What is the non-traded REIT’s proposed exit strategy? In other words, approximately how long will the REIT managers expect it would take to achieve liquidity?
Most non-traded REITs claim that their main goal is to achieve a liquidity event. Although non-traded REITs could achieve liquidity through a number of avenues, the most promoted goal is to eventually list the REIT in the stock market. Historically, however, only a handful of non-traded REITs have successfully achieved public listing.
Although most non-traded REITs offer a redemption program, oftentimes that program is suspended indefinitely. In other words, prior to the non-traded REIT achieving a liquidity event, the shareholder’s entire investment is, for the most part, illiquid.
Most non-traded REITs claim that liquidity events usually occur 7 to 10 years after inception. Investors should be aware, however, that non-traded REIT managers can (and oftentimes do) extend the liquidity event date by a number of years. Additionally, a liquidity event does not mean that investors will receive any profits from their investment or even get their money back.
3. Who owns the sponsor company, who are the managers who will be servicing the REIT and what are their fees?
As mentioned above, many non-traded REITs employ their own subsidiaries, managers, brokers and employees to service the REIT. In turn, these services are paid a pre-determined percentage fee outlined in the prospectus. A clear example that sheds light to this structure is the Cole Credit Property Trust I. Below is a chart filed by Cole with the SEC:
The chart above reflects that Christopher H. Cole owns all the companies hired by the REIT to do appraisals, acquisitions, make investment decisions etc. This means that all the fees charged by the REIT go back to the same individual or small group of individuals. A number of other REITs have similar structures.
4. If it is an existing REIT, from where exactly are dividends being paid?
Many non-traded REITs outline in their prospectuses that they reserve the right to fund dividends and distributions from 1) loans made by the REIT; 2) returning the investor’s capital; and worst of all, 3) utilizing new investor’s money to pay current investors. For example, below is language found in Behringer Harvard REIT I filings with the SEC:
“We have paid all or a portion of our distributions from the proceeds of our final offering or from borrowings and may continue to pay all or a portion of our distributions from borrowings. For tax purposes, 100 percent of the amounts distributed by us in both 2010 and 2009 represented a return of capital.” (Annual Statement filed March 8, 2011)
Similar language is found in filings by Cole Credit Property Trust, Wells REIT II, Hines REIT and Apple REIT Ten.
5. Has the issuer of the non-traded REIT operated and/or offered other non-traded REITs in the past?
This question is important because several of these REITs have previously launched REITs that have caused tremendous losses for investors. Many non-traded REITs currently have other REITs closed to investors in which they have significantly reduced their dividends; re-priced the share value, causing tremendous investor losses and even suspended redemptions indefinitely. For example, on Dec. 30, 2011, Behringer Harvard Opportunity REIT I sent a letter to shareholders, announcing yet another devastating decline in value per share to $4.12 – a drop in value of almost 60 percent from its original price of $10 a share. Nevertheless, despite having three different REITs reporting huge losses to investors, Behringer Harvard has launched yet another REIT currently open to investors: the Behringer Harvard Opportunity REIT II.
We believe that previous performance of a particular REIT can serve as an indication of how the new REIT might perform. It is important to remember that, in most instances, the new REITs are managed by the same group of individuals who manage the poor performing REITs.
In addition to asking the above questions, it is also important for investors to inquire about the broker-dealers selling non-traded REITs. Non-traded REITs are so defectively designed that big wire houses such as UBS, Wells Fargo, Merrill Lynch and Morgan Stanley Smith Barney do not sell them.
Consequently, based on our experience speaking to investors seeking legal representation, non-traded REITs are usually sold by lower tier brokerage firms that normally do not carry enough insurance nor maintain enough capital to compensate investors who pursue claims related to the inappropriate promotion and recommendation of these products.
Vernon Healy’s investment fraud attorneys continue to represent investors nationwide who have collectively suffered millions of dollars in REIT losses from REITs such as Behringer Harvard, Desert Capital, Inland, KBS, Wells, Cole and other non-traded REITs.