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A REIT is an entity that owns and operates income-producing real estate and distributes the income to investors. REITs pool the capital of numerous investors to purchase a portfolio of properties which the typical investor might not be able to buy individually. To qualify as a REIT, a company must have most of its assets and income tied to a real estate investment and must distribute at least 90% of its taxable income to shareholders annually in the form of dividends. Investors depend on the sale of properties or listing for the return of their principal.
Most REIT shares are registered for trading on a national securities exchange. Publicly traded REIT shares are widely followed by securities analysts. Their share prices fluctuate with changes in the REIT’s portfolio and economic conditions. Other REITs are referred to as non-traded REITs, as their shares are not registered for trading on any exchange. Investors in non-traded REITs who seek to sell their shares before the term of the investment must either resell their shares to the sponsor or sell in an inefficient secondary market, usually at severe discounts. Because non-traded REIT shares do not trade in an open market and are rarely the subject of analyst reports, investors depend on the disclosures made by the sponsor for information about the value of the REIT’s shares. Non-traded REITS are typicaly illiquid, expensive, and underperform their traded counterparts. Non-traded REITs often pay 10% or more in commission to the salesmen and charge ongoing marketing expenses as high as 2-3%. As a result, the non-traded REIT will have to return as much as 12-13% to simply break even.
Under FINRA Rules, brokerage firms have an obligation to make only suitable recommendations and to fully disclose all risks associated with a recommended product, including the fact that REITs are illiquid products. Moreover, brokerage firms have a duty to conduct a reasonable investigation of the issuer and the securities they recommend before approving them for sale to their customers. In October 2011, FINRA issued an investor alert about public non-traded REITs, urging investors to perform a careful review before investing. The alert states that FINRA is issuing this alert to inform investors of the features and risks of publicly registered non-exchange traded REITs. If you are considering a publicly registered non-exchange traded REIT, be prepared to ask questions about the benefits, risks, features and fees. FINRA further advised investors to: “[b]e wary of pitches or sales literature offering simplistic reasons to buy a REIT investment. Sales pitches might play up high yields and stability while glossing over the product’s lack of liquidity, fees and other risks.”
Investors purchasing REIT securities often were unaware of the risks and illiquidity associated with those securities, and sometimes were misled into believing that non-traded REITs are a safe, income-producing investment similar to high quality fixed-income securities. In some cases, an investor’s REIT may have little to no value as the REIT has filed for bankruptcy protection. In other instances, an investor is unable to access the money placed in a REIT because of the illiquidity of the product. In either case, our law firm represents investors against the brokerage firms who recommended that they purchase REITs, and files claims to recover losses sustained and/or recession of the investment in the REIT. In many instances, an investor can maintain real estate exposure in well-diversified, low-cost, publically traded mutual funds, like Vanguard, with better performance.
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