23 July 2019

Limits Are Urged for Some REITs

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State securities regulators are pushing for restrictions on a popular type of property investment trust, saying added protections are needed for small investors who may not fully understand the risks. The North American Securities Administrators Association, which represents state securities regulators, plans before the end of the year to propose guidelines that, if adopted, would significantly change the way nontraded real-estate investment trusts are sold and managed.

The group has been circulating to the nontraded REIT industry 33 recommendations focused primarily on the investments, including those that would limit how much of an individual's net worth could be put into any single REIT and curtail the ability of REITs to pay distributions to investors, primarily through dividends, immediately after raising money from shareholders.

States typically adopt the association's recommendations, and those that do can fine or take other administrative actions against REITs that don't comply, such as revoking a license to issue securities. The regulations indirectly affect independent brokers as well, by opening them up to enforcement actions from state legislators if they don't follow guidelines.

Regulators in several states, including Massachusetts, Ohio and Washington, have said they are worried about the rapid growth of the industry. Industry officials haven't officially responded to the specific draft guidelines and support any changes that make these investments more transparent.

Nontraded REITs buy office buildings, stores and other commercial properties. Shares are sold directly to investors by financial advisers and brokers, but they don't trade on exchanges like conventional REITs.

The REITs must pass along at least 90% of their income to shareholders in the form of dividends. Sales have more than tripled since 2009, with investors attracted by dividends of 6% or higher and share prices that stay relatively stable. Investors typically aren't able to sell their shares in the company until an event such as a sale, merger or listing of the whole company takes place.

Nontraded REITs have been investigated by regulators, including the Financial Industry Regulatory Authority, or Finra, and Securities and Exchange Commission, for inadequate disclosure of risks and their high fees, which typically range from 12% to 15% at the time of sale. Some state regulators also are concerned that many funds start to pay dividends to investors immediately, using money raised from investors, rather than from the operating profits of their real-estate portfolios.

In some cases, brokerages were the subject of enforcement actions for putting more than 10% of investors' net worth into a single nontraded REIT, a violation of the state's existing regulations.

Commonwealth declined to comment. LPL and Lincoln said they have cooperated with Massachusetts officials and resolved all issues. Ameriprise didn't respond to requests for comment.

This year, Finra, Wall Street's self-regulator, unveiled rules meant to make the industry more transparent by requiring brokers to factor fees into the valuation of REIT shares on customer account statements. That rule change is awaiting approval by the SEC.

Fundraising by nontraded REIT sponsors has skyrocketed since the financial crisis, as brokers capitalized on small investors' wariness of the stock market and investors hunted for high-yielding investments in a low-interest-rate environment. In 2013, nontraded REIT fundraising hit a record of $19.6 billion, and this year they are on pace to meet or exceed that amount.

Some states already have concentration limits that keep brokers from selling investors more than a certain percentage of their net worth in REIT shares, but the proposed guidelines would standardize these limits across every state. Another guideline would either prevent REITs from paying dividends out of investor capital or at least limit how long REITs can do so.

The REIT was listed publicly on the New York Stock Exchange last year as Columbia Property Trust Inc., at a share price that worked out to be a 45% discount to the share price at which investors originally bought into it.

Click here to access the full article on The Wall Street Journal.

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