Wednesday, January 20, 2010

Errors, Errors, Errors....
Here is an article with significant misrepresentations on non-traded REITs.  It is from some website called Before You Invest.  Here is the article titled "Behringer Harvard REITs Continue Trend in Non-Traded REIT Market:"
Investors who placed their money in unlisted REITs, including Behringer Harvard, have been awakened to the myriad of issues related to the nature of these products. Unlisted, or non-traded, REITS differ from listed REITs in that they are not traded on an open market. Rather, non-traded REITs are sold to investors who then hold the product until the end of an investment term.
Behringer Harvard and other non-traded REITs contain a fundamental flaw which is many times not evident at the time of purchase: their value is set by the very companies which sell them. To clarify, a listed, or public, REIT is valued daily based on the market in which it is traded whereas a non-traded REIT’s value is determined by the staff of the REIT, or sometimes by a third party consultant paid for by the REIT which it is supposed to objectively value. Obviously, a conflict of interest can easily develop in the standard valuation procedure of a non-traded REIT.
Another issue with non-traded REITs is that if one chooses to sell their shares, it must do so in conformity with the procedures of the REIT. The usual procedure is to sell shares through a redemption program; however, many such programs have been suspended due to adverse financial conditions when many investors attempt to redeem their shares at once. The consequence to investors is that they are stuck in the investment until the redemption program is reinstated.
When sold Non-traded REITs, many were not informed of these obvious drawbacks to the product. Some have posited that it might have something to do with the somewhat common 15% commission given to the selling party, or the broker. Though regrettable, many investors may be able to recover losses in such products, including Behringer Harvard, through arbitration.

This article is full of assumptions and misleading statements.  The title of the article infers that Behringer Harvard has done something wrong, which is not supported in the article.  I think that Behringer Harvard's non-traded REITs deserve extra scrutiny, but you don't learn why from this article.  Shock - non-traded REITs have their price set by their sponsor.  How else would a non-traded REIT or any other non-traded investment be valued initially?  The SEC requires that non-traded REITs provide a per share, net asset value eighteen months after the close of the offering period.  Non-traded REIT valuation is typically done by third parties, not the REIT sponsor.  The share valuation is not the largest single flaw of a non-traded REIT.  Larger flaws include non-traded REITs' inability to quickly access capital markets for equity or debt, and their outside management structure. 

By law, a non-traded REIT can only redeem up to 5% of its shares per year, or it changes the REITs registration status.  Sure, some REITs have suspended their redemptions, but not all.  All non-traded REITs are sold as illiquid investments. 

"When sold Non-traded REITs, many were not informed of these obvious drawbacks to the product," is a crazy, reckless statement.  How does the author know this?  Was he or she in client meetings?  Most non-traded REITs have significant disclosure, written in language that is not hard to understand.  All investors are required to receive a prospectus and meet suitability requirements.  The article implies that investors are not told of non-traded REITs' drawbacks because the selling broker makes a 15% commission.  First, the maximum amount a non-traded REIT can pay for offering expenses is 15%.  Most REITs offering costs are in the range of 10% to 12%, not the full 15%.  The amount of commission paid to a broker's broker / dealer is 7% plus a marketing fee that's typically 1% or less that the broker / dealer keeps.  The selling broker receives 90% or less of the commission. 

Non-traded REITs need analysis and investors need to question their brokers about the pros and cons of including a non-traded REIT in a diversified portfolio.  This article is irresponsible for its innuendo and lack of supporting facts.  Investors should look elsewhere for information than from Before You Invest.


Market Participant said...

The big issue with non-traded reits is that they are a bad investment, and that stockbrokers are greatly compensated for selling them. Figure in a typical non listed offering, an investor is getting $8.50 in real estate for every $10 invested. Meanwhile the broker gets a 7% commission on the sale.

Further the non-traded reit continuously offers new shares (at an effective price of $8.50/share) which leads to dilution of NAV, should it ever grow above $8.50.

That much could be avoided if the REITs would adjust their offering prices over time.

Most of the people sold shares of non-traded reits are unsophisticated investors, would not understand anything in the S-11, much less the subtleness of the non-traded reit model.

The whole thing is a giant annuity for the sponsor of the reit, and the 7% commission is merely the cost of acquiring passive and gullible capital.

Rational Realist said...

It is expensive capital, too. If you compute the cost of capital for non-traded REITs and compare to the IRRs or expected returns on the properties acquired, the cost will exceed the return. Non-traded REIT sponsors don't like when this analytic viewpoint is raised.

Linda D said...

I appreciate the critical analysis of this indictment by innuendo. We always need to be reminded to look carefully at the omissions in such articles.