There is no real estate investment I would work more diligently to avoid than a non-traded REIT. They routinely pay dividends out of investor proceeds peter or paul? and one of them, Wells Timberland REIT, doesn’t even qualify as a REIT. So what gives? It’s pretty simple: your friendly neighborhood broker is paid handsomely to sell them, regardless of whether it’s in your best interest to buy them.
Almost $9 billion in non-traded REIT equity was raised in 2008, a record that was easily eclipsed in 2009 after 11 non-traded REITs registered to raise a combined $19 billion. Officially, these non-traded REITs are gearing up to capitalize on opportunities arising from the recession and the distressed property market. Unofficially, it’s a commission and fee bonanza for everyone involved, and hapless retail investors are paying the freight.
Indeed, it would be easier and cheaper to hire Johnny Cochran to bail you out of a murder charge than to somehow come out ahead on a non-traded REIT investment. You would also be leaving much less to chance. In addition to the upfront commissions of 9-12 percent paid to your broker, there are individual property/asset acquisition fees of up to 2.75 percent, property financing fees of up to 1 percent, management fees of up to 5 percent, disposition fees of up to 1 percent, and asset management fees of up to 1 per annum, plus expenses. The net result is that out of a $10,000 initial investment, only about $8,000 would be left to actually invest.
Obviously, these fees encourage only two things: sales of non-traded REIT shares and purchases of property – any property – at almost any price. David Swensen, Yale Endowment’s chief investment officer, singles out the Wells REITs in his book, “Unconventional Success” (pages 70-75). Swensen obviously knows his way around alternative investments, and his opinion of Wells is unambiguous:
“No rational buyer can compete with the Wells acquisition machine’s willingness to overpay for product. As a consequence, investors suffer the double indignity of high fees and poor investment prospects.”
How then, are investors convinced to suspend common sense and buy these commission-laden pigs? In theory, non-traded REITs offer price stability and a reliable source of income, and those are the major selling points. But a quick glance glance at almost any prospectus reveals these key “features and benefits” to be nothing more than highly profitable gimmicks.
Officially, the share price is almost always set at something remarkably close to $10 by the REIT sponsor, and almost as remarkably, it never ever changes no matter what. This is true of almost all non-traded REITs, regardless of the quality of their assets, their location, leverage, current market conditions or how long the REIT has been in operation. This lack of transparency is somehow supposed to provide investors with comfort.
Realistically though, how could a brand new REIT with no assets and unproven management be worth the same $10 a share as a 5 year old REIT with $3 billion in diverse assets spread across the country, and the same as a 10 year old REIT with just $200 million in assets concentrated in one small market? It’s a $10 coincidence that is just as impossible as it is unbelievable.
In fact, the latter example is Whitestone REIT, a non-traded REIT that was the product of one real estate entrepreneur’s efforts to consolidate his real estate holdings in Houston. The result was a bitter dispute with Whitestone management that lasted almost a decade. Could this REIT still be worth $10 a share to the investors whose dividends were cut and whose shares can no be longer redeemed? It’s improbable, and recent Whitestone insider transactions value it at $5.15 a share, about half the “official” price paid by outside investors.
If egregious fees and lack of transparency weren’t enough to perfect this foul smelling stew, why not add conflicts of interest and fraud? For an example of the former, look no further than Inland American REIT, and Inland Western REIT, two non-traded REITs managed by the Inland Group in Chicago. Inland Western needs to repay $1 billion in debt this year, which may be an impossible feat. In fact, as we type, Inland Western is rather desperately trying to raise cash to avoid bankruptcy (see What Are Inland Western Shares Really Worth?).
But that’s no matter, especially since Inland Western can easily raise cash by selling its kryptonite to affiliates. Inland Western did just that earlier this year, pocketing $99 million in cash by selling two properties to Inland American. This was done at a time when commercial real estate sales volumes reached all time lows. Whether any of this was truly arms length and representative of fair market value is difficult to tell, but it seems unlikely .
Fraud and misrepresentation complete this cancerous portrait. This particular example is brought to you courtesy of the SEC which recently settled a non-traded REIT kickback scheme with W.P. Carey. According to the settlement, W.P. Carey paid nearly $10 million in undisclosed compensation – using the assets of the REIT – to a broker-dealer that sold shares of W.P. Carey’s non-traded REITs to the public. Carey executives then used fake invoices and misrepresented the payments in securities filings to keep it all secret. The arrangement benefited not only the broker-dealer, but also W.P. Carey, because the broker-dealer’s sales of REIT shares increased the management fees paid to W.P. Carey. In the settlement, W.P. Carey and 2 senior executives agreed to pay $30.3 million in disgorgement, interest and penalties.
In terms of the other key selling point, reliable income, non-traded REITs are not so reliable. Many, like Cornerstone Core Properties REIT, are busy funding their dividends from borrowings and returns of capital. Grubb & Ellis Healthcare REIT is a great (but not isolated) example of the lengths to which non-traded REITs will go to maintain their dividends. For the three months ended March 31, 2009, Grubb & Ellis paid distributions of $14,247,000, as compared to cash flow from operations of $5,895,000. In many cases, distributions paid in excess of cash flow ponzi scheme are paid using proceeds from new investors. Slowly but surely, these fictitious dividends are starting to be cut.
OK, so you made a mistake, and now you want out. Good luck brother – you’re stuck. As of the end of May, the six largest non-traded REITs have shut down their share repurchase programs. These include Behringer Harvard REIT I, Cole Credit Property Trust II, Inland American Real Estate Trust, Inland Western Retail Real Estate Trust, Piedmont Office REIT and Wells Real Estate Investment Trust II.
Other nonlisted REITs that have either stopped repurchasing shares or that have been unable to repurchase all the shares submitted include Behringer Harvard Opportunity REIT I, Desert Capital REIT, Dividend Capital Total Realty Trust, Grubb & Ellis Apartment REIT, KBS Real Estate Investment Trust and Whitestone REIT. It may be years, if ever, before investors experience a so-called “liquidity event” with these REITs.
There seems to be no boundary around the financial sleight of hand deceit played by some non-traded REIT sponsors. Lightstone Value Plus REIT claims to be on investors’ sides by allegedly allocating 100 percent of investor proceeds toward real estate investments and co-investing alongside shareholders. This is quite far from the real economic truth, and even a cursory read of the Lightstone “Value Plus” prospectus shows otherwise (read more on Lightstone’s investment prowess midway through this post). There’s really nothing not to like about these non-traded REIT scams, except everything.
Update: This post received almost 30 comments before I had to migrate the entire site to a new software platform and a new location on our server. Unfortunately, comments on several posts failed to port over to the new platform. I will either republish them here manually or post them to an online archive; I will update this note as I progress. In the meantime, if you have questions or comments, you’re welcome to post them here, but it may be best to post them on the brand new Non-Traded REIT Forum. The forum is searchable, you can upload documents and images (charts, graphs) – and you can post links. Over time, I expect it will become a very useful resource for shareholders. Everyone is welcome, including registered reps, wholesalers and broker/dealers. Cheers, RW
Click here for a list of non-traded REITs
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The following is from the Apple REIT VIII form 10-Q for the quarter ended 9/30/09. If I am an investor, is there cause for concern?
Statement of Cash Flows Analysis (000s)
CASH IN
Net cash from operating activities 36023
Net cash from selling stock 20334 Net cash from credit line 39055
TOTAL 95412
CASH OUT Capital Improvements -26700
Redemption of Common Stock -10193Cash Distributions to Investors
-56955
Payment of Notes Payable -1564
TOTAL -95412
Line of Credit: LIBOR +175bps 49300due Nov. 2010
Anonymouses 12/12/09 through 1/3/10:
1. I have never been burned by a non-traded REIT investment, nor has my 78 year old Mother, thank goodness. If anything, please criticize me for ignorance, as I have never invested in one. Surprise, surprise.
2. Shouldn't ALL non-traded REITs pay dividends out of earnings? (the retort in the comment was that MOST do, so I guess the commenter thinks that makes the rest OK.) What is the true yield of an investment that's paying you dividends with your own money?
3. Limiting redemptions means the REIT has no cash, cannot or will not sell assets, and you are therefore stuck for years, possibly many, many years. Did/does the sales literature fully explain this risk? What is the true value of an investment that you are unable to sell?
4. I have heard the "13 REITs have gone full cycle" quote before; it came from a Stanger and Co. article on NTR returns, which amounted to a pathetic low single digit blended IRR, if I remember correctly. What Stanger and crew has not published is the number of REITs that have NOT gone full cycle. I would love to know that number, and yes, it is much larger than 13.
5. Apple REIT VIII 10Q. This is perfect! They generated $36MM in cash from operating activities, yet they paid $56.95MM in distributions (and redeemed $10MM in stock). Where do you think they are they getting the money to cover the shortfall?? FYI, L+175 has 2006 written all over it.
Cheers, REIT Wrecks
Any registered representative and their firm has an obligation to satisfy the suitability requirements for selling a NTR to any investor. If the investor requires liquidity, a NTR isn't suitable, nor is any real estate investment. It's not a bank account, it's a long-term investment that is designed to provide income from lease income and the potential of capital return and capital gains upon liquidation or liquidity at public offering. I have sold Wells REITs for many years to clients who are suitable and have zero problems with their investments or service. I have found their principals, field personnel, and home staff to be prudent, experienced, risk/leverage averse, reliable, customer service-oriented, and highly trained. I have met the principals and my firm has done its due diligence. Through the financial crisis, their investments continued to privide a steady income to my clients and Piedmont is now in preliminary proceedings to go public, now that market conditions have improved. I don't know why the "former employee" left, but I suspect the problem was with him, not the firm. The commissions described by this blogger are inflated. 6-7% is more like it, which is only 1-2% more than an A-share mutual fund. The blogger is obviously not a registered representative with any real experience. The risks of these investments are fully disclosed to investors at my firm and investors are not allowed to invest more than 20% of their investable net worth, or if their liquidity needs contraindicate their participation. NTRs are a tool. Properly used, they function very well. But, any real estate investment's success depends on the skill of the buyer to make good deals at the front end to maximize their long-term capital potential at the back-end, and the skill of the management team to fully lease and maintain the value of the properties and the stability of the cashflow. In my experience, Wells has done that in good markets and bad. Before you make blanket accusations, you should have specific facts to back them up. Wells may take some interest in your comments, now that they have been alerted to your publication.
I have also worked temporarily in Ray Lucia's office, so I have seen them from the inside. Ray and his team are knowledgable and ethical. Ray is also a marketing genius. He has key people working with clients behind the scenes who are ethical and whose expertise has been tapped numerous times to appear in court as expert witnesses. If I had only one criticism of Ray's group, they have so many clients, they may not provide as much face time with clients as they or their clients might like or perhaps need. However, his strategy is overall sound for longterm investing. But, I wouldn't dream of talking to him or his staff about individual stock or bond trading, sector rotation, technical analysis, or options work.
Great. Here we have a retail broker hiding behind FINRA's smoke and mirrors on "suitability".
Bren, in terms of what's most suitable for your clients, when you talk to your clients about the investment advice you and your firm provide, do you explain the difference between the suitability standard and the fiduciary standard?
Do all of your clients know that the suitability standard is much lower? Do you make your clients aware that under the suitability standard, you are not required to act in their best interests at all times – as you would if you were a fiduciary?
In addition to fully disclosing all the risks and doing your due diligence (very good Bren, A+ for effort), do you fully explain all the conflicts of interest you have with your clients?
Do you fully explain, for example, that you may choose to sell them a certain product simply because you and/or your firm earn a higher commission (in one form or another) – even though lower priced "tools" exist and they could be just as effective?
As for the commission amounts specifically, I would love to know of an A class share in any mutual fund that scrapes 15% of investors' cash straight off the top, regardless of who gets it and what it's called. Good grief, even the endangered B shares don't attempt this miraculous feat.
In terms of defending the merits of these things, it's just not easy. One comment that has made the most sense so far is that most small investors don't have $250,000 or more to pony up for a down payment on an office building or a shopping mall (assuming, for the moment, that you are an asset allocator and you agree that public REITs are correlated to stocks, then it's true that direct real estate exposure would be desirable).
For those investors, these products might make a little bit of sense. However, do these small investors really need CRE exposure, given the considerable risks and the high costs of these vehicles in particular? Most of them already own a home, isn't that enough exposure to real estate?
In the final analysis, once again, I really can't think of any reason why you would willingly buy one of these things, or not be suspicious of the person who tried to sell you one (unless, of course, that person and his or her broker/dealer, in their collective zeal to achieve client asset allocation of the highest order, had agreed to waive all commissions).
By the way, Bren, when you turned me in to Leo's peeps, did you invite them to visit my sponsors at the top of the page? It would be nice if they could do that. Hosting this thing is expensive, lots of bandwidth required and all that, and every little bit helps. TIA!
Greatly enjoy reading this. Especially the remarks. Slanderous?! Biased? Must have gotten burned by a bad investment? Are you adding depreciation? (exactly what your 78 y/o mother would want to hear, right?) Just because Leo fired you? You must work for a competitor?
Indeed REIT Wrecks, these products are difficult to defend, hence the attacks of 7% commission only being about 2% higher than the highest load mutual fund.
Seems that those defending Wells REIT are salesmen, adding credence to the contention that these products are sold, not bought. I can nowhere in the blogosphere find an investor who speaks favoribly of Wells REIT. I have not followed any other of what they now call NTR's. But regarding Wells…
I attended a sales seminar at Wells in about 2003 and have never seen anything quite like it. They had raised tons of cash and seemed giddy. I happened across an old piece of literature stating Wells wanted to abide by "Biblical investment principles." I inquired what was meant by that and was informed that Wells does not use debt to purchase property. Apparently, they gave up this strategy. Looking at their Timber REIT filing, an investor is doing nothing more than paying off mezzanine debt. So much for the Biblical approach.
All the God talk stirred up the cynic in me, so I decided to follow Wells at that time to see if they were for real or a scam. I got the "too good to be true" feeling. Since visiting in 2003 I have regularly viewed Wells statements on the SEC site, do google searches, and used to have a "mole" within the organization. I am still not convinced that "scam" applies, but it sure is hard to get one's money back.
I particularly enjoyed your paragraph about the difference between fiducuary and suitability. If the writer does not know what fiduciary means now, they probably will very soon. Wells is defending itself against Washtenau county for breach of fiduciary responsibility. The class was recently certified and hopefully those who need their money will get it back. So Indeed, suitability is nothing but smoke and mirrors. Determining suitability is done by the honor system.
Perhaps most disappointing is Wells inability to meet deadlines within a reasonable timeframe. Those who invested in the first offering of REIT I (now Piedmont) were informed the holding period would be 5-7 years. Original investors are now in year 12. Wells has a LOOOONG history of failing to meet deadlines. Based on track record, the listing or liquidity event will take years to come to fruition. Actually, it already has. In their attempt to finally list, Piedmont has again proxied its investors, this time to approve a 3:1 reverse split. If, as Wells has always stated, the shares are immune from market volatility, the shares should be worth $30 each if the split is approved.
The wholesalers at Wells are very good at what they do. It could be because those people are religious fanatics. We're talking prayer-chains for favorable acquisitions, crucifixes throughout the office, chants of "amen" when St. Leo says something dogmatic, which to some of his minions is every other sentence. I have never in my life seen a more egregious use of religion to market products, and that includes televangelists.
In closing, if Wells delivers a favorable long-term return on their REITs, then the commissions and management fees may have been well spent. But so far, there is nothing that should give anybody optimism. Look into Wells LP1 – LP14 for a company track record. You will find ZERO, I repeat ZERO that met the objectives in the prospectus.
Looks like investors are lawyering up too. I expect this to get interesting.
I too apologize for the length and have visited your sponsors.
Funny. Perhaps they could add the Church of England to their prayer list. Those Anglican heathens just lost $250 million on their 2006 Stuyvesant Town investment. (lenders foreclosed on it last week.)
Anon, thanks for your support, I appreciate it very much, and don't apologize for the length of your remarks – I enjoyed reading them. Well penned! All of these comments have been great.
As a matter of fact, they have **inspired** me!
I just created an entire forum dedicated to sharing information on Non-Traded REITs. You can check it out HERE.
The inaugural topic has already been created. It's about Apple REITs, and it's absolutely perfect. It was started by an Apple REIT investor, and he is wondering whether his shares are still worth $10. Of course, his broker at David Lerner assured him they were, which is just flat out fiction.
Anon, you mentioned that you have some track record data on some of the Wells programs – if you would be willing to share some or all of that, I would appreciate it if you could visit the Non-Traded REIT Forum and post it there. You can upload attachments and you are also welcome to post links – the forum's BBcode for urls is easy to use.
If anyone else reading here would like to join, everyone is welcome. As I said earlier, equipped with the right information, investors can easily make the choice that's right for them.
I've worked in the retail sector for many years now and have sold (and personally bought) a number of various REIT offerings to a number of my clients over the years.
Prior to "The Meltdown," people loved these things… the CNL Retirement was especially nice… paid well and regularly and went liquid to the tune of a nice fat capital gain…
However, I also sold some Inland Western and American that, well… simply suck.
However, every client that ever purchased a REIT knew that liquidity, while it was never a problem before, could end up being one. And they knew that, like any investment, the return they see could be end up being negative.
Obviously, while they are not exactly thrilled with how things have gone down, they don't hold me personally responsible. I personally own a piece of every REIT I've ever sold.
The Point? A suitable REIT investor is not one that barely meets the listed suitability standards. Nor should a REIT be anything more than a minor addition to a well diversified portfolio. Caveat emptor? Always!
But there are plenty of investments that have gone south over the last couple of years… how's your residence doing these days? Are you pissed off at the real estate agent?