By Bradd Milove
have received a lot of bad press in the past year (including coverage in our own securities and investment law
last month). But despite the many risks associated with such investments, it would seem that they are here to stay. In a recent
Wall Street Journal
report, experts noted that non-traded REITs have generated more than $73 billion in the last decade, despite the effects of a crippling recession. And that kind of profit, coupled with the attractive selling points of many real estate offerings, has industry commentators predicting that even government regulation and heightened scrutiny won’t suffice to pull these tricky investments from the market for good. Therefore, it is important for investors to have a firm grasp on the fine print when it comes to private placement and non-traded real estate investments; and to understand the steps that government agencies are taking on investors’ behalf in order to minimize their chances of being victimized by real estate investment fraud.
Unlike publicly traded REITs, non-traded REITs are private – meaning that they do not trade on the national stock exchange and are thus highly illiquid, making it difficult for investors to redeem their shares in a pinch. They are also subject to substantial up-front fees that can oftentimes total in excess of returns; and on top of all this, the private nature of non-traded real estate investment trusts makes it possible for unscrupulous promoters to manipulate distributions and take advantage of unsuspecting investors due to decreased regulatory oversight. One of the most common practices among promoters of non-traded REITs is the use of investor principal as a substitute for property generated income: in other words, the promoters pretend to give their clients funds earned from property operations, when in fact they are simply paying them with their own invested money to conceal low or non-existent actual income. In response to this activity, the SEC and FINRA have taken action to help educate and protect investors – and to discourage promoters from taking further advantage of the private investment system.
Investor safety checklist: what to do when considering a private placement real estate investment
In spite of the fact that countless individuals have been scammed at the hands of dishonest “private placement” and non-traded REIT promoters, these investments are still an appealing option for many individuals thanks to the promise of higher income when compared to those associated with fixed income alternatives. Particularly when pitched from this perspective, private placement real estate offerings hold enticing potential; and that’s why the SEC published the following tips in a recent
Corporate Finance Disclosure Guidance report
to help investors minimize fraud risk before sinking money into such funds in the future.
When brokers offer a real estate private placement, investors should be sure to address the following concerns with their promoters (all of whom should disclose this information according to SEC guidelines):
- Insist on an even discussion of both the risks and rewards associated with the investment in question.
- Check to make sure that all sales materials information is consistent with that included in the investment prospectus
- Inquire about the schedule and source of investor distributions – and ask specifically if earnings are generally high enough to cover those distributions without the need to dip into investor funds.
- Confirm property ownership information and details, ask for information about redemption programs, and consult market performance data prior to making a decision.