Non-Traded REITs Can Yield Unpleasant Surprise

Non-traded real estate investment trusts (REITs) have become a controversial investment – and apparently growing more so by the minute, according to their many critics. The reason behind the controversy has to do with the lack of valuation transparency surrounding non-traded REITs, as well as their complexity, unique risks and other issues.

As their name implies, non-traded REITs are not publicly traded investments like stocks. Non-traded REITs also have limited and lengthy redemption periods, along with exceptionally high commissions and other upfront fees and charges. Perhaps most unnerving to investors is the fact that the method for determining the share value of a non-traded REIT can be across the board and vary widely.

For instance, some REIT sponsors use third-party appraisers or investment banks to determine current property value; others rely on their own management. With either method, the valuation can oftentimes be a far cry from the true value of the investment.

Case in point: The Cornerstone Core Properties REIT disclosed in a regulatory filing earlier this year with the Securities and Exchange Commission (SEC) that its stock – which was originally sold to investors at $8 a share in 2008 – is actually valued at $2.09. Until 2012, however, Cornerstone has consistently noted in its regulatory filings the initial offering price, with no new updates.

As reported April 24 by the Wall Street Journal, Cornerstone CEO Terry Roussel commented on the matter in a letter sent to shareholders in March in which he stated that the value of the stock had to be reduced based on falling values of the industrial parks that the REIT previously purchased during the height of the market.

To no surprise, the response has not gone over well with investors. In turn, many are taking their dissatisfaction and filing grievances against the investment advisers who sold them non-traded REIT investments. In 2011, the Financial Industry Regulatory Authority (FINRA) had received 54% more complaints over non-traded REITs than it did two years ago.

Last year, both the SEC and FINRA began taking a closer look at non-traded REITs. Among other things, the agencies called upon sponsoring companies to provide better disclosures on the way shares are valued and any potential conflict of interests with third-party advisers.

For some investors, however, the new scrutiny is too little, too late. As reported in the Wall Street Journal article, Robert Block, a 74-year-old retiree living in Cape Coral, Fla., invested $412,000 in four non-traded REITs from 2006 to 2008 because his investment adviser told him the dividends were attractive and the REITs were “about as safe as anything you could get.”

The broker’s advice didn’t pan out. As of the first quarter of 2012, Block’s $400,000 investment was valued at about $300,000 based on REIT share valuations.

“I needed income that I could count on and wasn’t risky,” Block said the article.