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Real Estate Investment Trusts (REITs)

A real estate investment trusts (REIT) are a security that invests in real estate directly either through properties or mortgages. REITS generally pool capital of numerous investors to purchase a cadre of properties. These properties can include hotels, shopping malls, apartment buildings or office complexes. These properties are usually too expensive for the average investor to purchase on his or her own.

Generally, REITs can be publicly or privately held. Publicly held REITs can be sold on an exchange and publicly traded. Non-traded REITs are sold through broker-dealers and are private. Both exchange traded REITS and non-traded REITs investment in real estate and are subject to the same IRS requirement that the REIT must distribute ninety percent (90%) of its taxable income to investors. There are four main differences between REITS traded on an exchange and non-traded REITs:

  1. The Listing Status. Non-traded REITs are not listed on an exchange while traded REITs are listed on exchange. The main difference is that traded REITs provide liquidity and price transparency and non-traded REITs do not.
  2. The Tradable Market. Non-traded REITs have a very limited market and while some shares may be redeemable by the REIT or a secondary market may pay a significantly reduced price for the REIT shares, the exchange traded REITS are easy to buy and sell.
  3. Front end fees: The front-end fees for non-traded REITs are enormous and can be as high as 15% of the asking price. Generally, with exchange traded REITs the fees are closer to 7%.
  4. The Anticipated Source of Return. Non-traded REITs rely on the payment of income over time and the hope that the REIT can be sold in 5-7 years. Exchange traded REITs tend to seek capital appreciation relative to its market price.

Whether traded or non-traded, REITs are generally classified as equity, mortgage, or hybrid.

Equity REITs invest in and own property. The revenue for equity REITs come principally from the rent roll from the properties they own. Mortgage REITs invest and own property mortgages. Mortgage REITs loan money for mortgages to real estate owners, purchase existing mortgages, or mortgage-backed securities (MBS). The revenues for Mortgage REITs are earned through the interest that they earn on mortgage loans. Hybrid REITs combine investment strategies from equity REITs and mortgage REITs and invest in property and mortgages.

REITs are generally valued and examined using the net asset value (NAV), funds from operations (FFO), and adjusted funds from operations (AFFO).

Increased volatility in stock markets has led many investors to look for investment products that are more stable. Some non-traded REITs have claimed to offer stable returns in the volatile real estate market. As the Financial Industry Regulatory Authority (FINRA) and the Securities Exchange Commission (SEC) have recently noted, these products may not be as safe and stabile as advertised. As the SEC noted, a common sales tactic of broker-dealers that sell non-traded REITs is to claim they are able to eliminate volatility. However, the problem is that the REIT determines the value of its assets and therefore investors may simply not know about the volatility.

Recently, stock brokers and investment advisors have aggressively marketed REITs to investors because the products offer attractive commissions to brokers. Another problem with non-traded REITs, which have become very popular, is the valuation of the non-traded REIT. Broker-dealers that sell non-traded REITs either use net investment valuation or appraised value valuation. The Net Investment Methodology requires broker-dealers to disclose whether the distributions are return of capital or income and can affect the per share value. The appraised Value Methodology requires using the appraised value of the issuers most recent public filing. However, the valuation is required to be preformed only annually.

The REIT attorneys at Gana Weinstein LLP have extensive experience arbitrating REIT cases. If you invested in a REIT and need an attorney to evaluate your investment and determine if it was appropriately recommended, contact us.

Securities Lawyers Blog - REITs
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