Opinions and insights on alternative investments with a focus on real estate securities.
There is an old Scottish Proverb that says “Open Confession Is Good For The Soul.” As I read yet another indictment on the Non-Traded REIT industry (Bloomberg News Report June 2, 4:18 A.M.), I can’t help but wonder if this is an industry that needs to confess some of its bad behavior and institute sweeping reforms. We are witnessing a growing number of failed non-traded REIT and other Direct Participation Programs, representing thousands of investors who have lost millions in reduced dividends and billions in deteriorated asset values. Numerous articles and publications now routinely refer to many direct real estate and REIT programs as Ponzi schemes. I don’t know about you, but I’m highly uncomfortable investing in any program that draws comparisons to the likes of Bernie Madoff, Allen Stanford, and Marc Dreier. Of course, as industry insiders are quick to point out, non-traded REITs and their commercial real estate investments are victims of the same lousy economy that has torched every other asset class, and critics should not be so quick to throw the baby out with the bathwater. True enough, but this is where advisors and investors need wisdom and discernment. There is a huge difference between “unknown” external market risk versus the “known” internal risk that results from excessive fees and expenses, weak transparency, confusing accounting and financial measurements, conflict-ridden boards, and generally misaligned interests. Industry leaders should stop managing appearances and start managing change. Quit hiding behind statements like “we disclosed the risk”, “we gave them a prospectus” or “it’s just too confusing for the average investor to understand.” How about aspiring to a higher standard of excellence that says: “let’s not just disclose risk, let’s make sure that investors really understand it!” Instead of asking—is it legal…how about asking —is it ethical?” And as for the idea that many of these investment structures are just too confusing for the average investor…Warren Buffet has a thing or two to say about opaque investment structures. “Investment must be rational and understandable, if you don’t understand it, don’t do it.”
Excellent comment. I'm not indicting the entire non-traded REIT industry, far from it. I am trying to point out situations where marketing and complexity (or both) are outpacing operational reality. There are some good non-traded REIT and other real estate sponsors who are working hard for investors. It is frustrating that a few sponsors are experiencing high profile problems. Investors need to realize that the real estate prices have declined and credit markets have tightened. Investors need to question and understand the fees they are paying, and pass if their broker can't provide thorough answers. In addition, investors need to question distributions. Any investor will understand that an investment paying out more in distributions than it's earning is unsound and not sustainable. Finally, an investor needs to understand what the REIT or real estate investment is buying. If a deal is too complex, and there are some incredibly complex deals available, an investor should pass and look for another real estate investment.
I agree, we should not punish the many for the sins of a few. The problem is that the few are starting to outnumber the many. My comments about necessary reforms stem from the Bloomberg article that points out FINRA has stepped up its scrutiny of the non-traded REIT industry by opening formal investigations into “marketing, advertising, disclosure, suitability analyses and more.” By some estimates, nearly 75% of current non-traded REIT programs are paying out more than they earn. Estimates vary, but payout ratios range from a low of 110% to a high of 300%, with an average of ~140%. In the most egregious cases, some Sponsors actually manufacture dividends from negative operating earnings. This is simply bad behavior and should not be justified as yield smoothing in order to offset the negative drag of upfront sales commissions, fees, and expenses. This is presuming to heavily on the future, and is a dangerous way to run a business. At their core, dividends should be a barometer of healthy unit economics not a disguised marketing plan. The industry needs to practice some self-governance and not let FINRA do the job. For those doing it right, reward them with an allocation. For those who are not staying in bounds, don't keep feeding the tiger.
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