In the period from 2008 to 2011 REITs have faced challenges from both a slowing United States economy and the global financial crisis, which depressed share values by 40 to 70 percent in some cases. As a result, many investors have seen their REIT investments plummet in value, despite promises from their brokers and financial advisors that REITs are a “conservative” or “stable” income producing investment. Recent events have proven otherwise.

A Real Estate Investment Trust (REIT) is an entity that invests in real estate deals, and which usually offers shares for sale to the investing public. Some REITs are publicly traded companies, some are not. Some are sold to investors as privately held partnerships. REITs are primarily in the business of buying and managing real estate and must distribute most of their profits each year to investors.

REITs can own or invest in real estate, real estate-related loans or both. However a set list of conditions set forth by the IRS must be followed in order to qualify as a REIT. They can fall into one of three broad regulatory categories. Firstly, they can be “public listed” REIT, which means that they are registered, usually with the SEC, and publicly traded. The second type is a “public unlisted” REIT, which is registered but is not listed nor traded in any exchange. The last type of REIT is a private placement REIT, which is neither registered nor traded on an exchange. REITs which fall under the last category tend to file an SEC “Reg D” form which exempts them from having to file most disclosure documents, which limits their marketing to wealthy or “accredited” investors.

REITs normally qualify with the IRS as a real estate company that agrees to pay out at least 90% of its taxable profit to investors (and meet other important requirements). REITs normally avoid corporate income taxes if they meet IRS rules. REITs distribute nearly all of their profits and in return they are not taxed on profits.

REITs have been sold by brokers in the past few years as a conservative, income producing investments. However, REITs normally pay brokers relatively high commissions and expenses, giving brokers to sell nonpublic REITs as stable, income producing investments appropriate for retirees and near retirees. The fact is that REITs have significant risks: lack of liquidity, lack of transparency, and full of expenses that benefit the sponsors and brokers that sell them.

REITs are regulated. However, even if a non-traded REIT is allowed by the state to go public, it doesn’t remove the associated risk that is inherently within the product. Generally it is up to financial consultants to make determinations as to whether the investment is good for their clients.

A few of the public non-traded REITs pay distributions from the offering proceeds or borrowings. This might indicate that the REIT is possibly short on cash, which is something customers may be unaware of. In the past, federal regulators have acted in some of these controversial deals. For example, in July 2009, Minneapolis-based Ameriprise Financial Services Inc. agreed to pay $17.3 million to settle charges brought forth by the SEC stating that they received millions of dollars in undisclosed compensation as a condition for offering and selling REITs to its brokerage customers. These offerings included $100 million of unregistered REIT shares. In recent years, the Financial Regulatory Authority (FINRA) began reviewing broker dealers sale and promotion of non-traded REITs, in both public and private placements and in targeted examination requests.

FINRA member notice 09-09 issued in February 2009 clarified the rules on public and private placement non-traded REITs. Member firms, FINRA says, may not use par value in a customer account statement for more than 18 months after the conclusion of an offering. Furthermore, prior to taking part in a public offering, they must determine whether all the material facts have been adequately and accurately disclosed, including if the promised dividend distributions will be sustainable.

Jeffrey Sonn, Esq., who represents investors in REITs, says that high commissions on private REITs provide a large incentive for REITs to be heavily pushed and inappropriately sold to some investors. “Brokers too often tell customers that it is a safe income producing investment without warning of the true risks, such as a lack of liquidity,” said Sonn. “It’s a good deal, they often say,” added Sonn, “but that’s not necessarily true.”

Because nonpublic REITs are not traded publically, REIT managers determine the value of the portfolio themselves, as opposed to free market valuation. This creates a conflict of interest with the managers who selected the properties for the REIT being the same ones that determined their value. The higher the share price, the higher the management fee for the REIT managers. However, when investors try to sell their nonpublic REITs, they sometimes find that brokers give them quotes below the value on their statements, or they cannot sell them at all.

Investors who have been duped into buying nontraded REITs may have significant claims against their brokers. For more information, contact Jeffrey Sonn at or 305-912-3000.