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The Risks Of Non-Traded Reits

During drawn out periods of low or non-existent interest rates, investors often begin seeking high-yield products. One such product is the real estate investment trust that is not traded on an exchange, commonly referred to as a "non-traded REIT" for short. So what is a REIT? According to FINRA, a REIT is "a corporation, trust or association that owns (and might also manage) income producing real estate." Essentially, REITs collect capital from investors to purchase properties.

Non-traded REITs and exchange traded REITs share many features, but differ significantly. Most importantly, non-traded REITs do not trade on a national securities exchange. For this reason alone non-traded REITs are generally illiquid for long periods of time. Investors should beware that the yield associated with non-traded REITs is also generally subsidized by leverage and include return of capital in the yield. Contrast this mechanism for paying yield with dividends paid by corporate stock, and an investor has cause for concern.

A non-traded REIT (as compared to an exchange-traded REIT) have high front-end fees embedded in the share price and the secondary market for this type of REIT is very limited. In addition, because non-traded REITs do not trade on an exchange, broker-dealers involved in selling these product to investors are only required to provide valuations within 18 months after the cessation of the offering of shares. The delay in valuation can cause a delay in the disclosure of seismic changes in the value of the underlying non-traded REIT as we saw with the Apple REIT 10 product in 2011.

On May 27, 2011 FINRA's Department of Enforcement brought action against David Lerner Associates, Inc. and David Lerner for the unsuitable sale of Apple REIT Ten - a non-traded REIT. According to FINRA, David Lerner and his broker-dealer sold over $442 million worth of Apple REIT Ten to without performing adequate due diligence and targeted unsophisticated and elderly investors in the product. According to the complaint, David Lerner did not disclose that the income was being partially funded by the return of investor capital. The case ultimately settled in October of 2012. Mr. Lerner was suspended from the industry and the firm was fined approximately $14,000,000.

The moral of the story is that investors should be very careful to understand that non-traded REITs are generally illiquid and that what may seem like a dividend could actually be a return of capital.

For further discussion on REITS visit: http://www.ganalawfirm.com/