October 5, 2011

FINRA Issued Investor Alert on Public Non-Traded REITs

This week the Financial Industry Regulatory Authority (FINRA) issued a new Investor Alert called Public Non-Traded REITs-Perform a Careful Review Before Investing to help investors understand the benefits, risks, features and fees of these investments. While investors may find non-traded REITs appealing due to the potential opportunity for capital appreciation and the allure of a robust distribution, investors should also realize that the periodic distributions that help make non-traded REITs so appealing can, in some cases, be heavily subsidized by borrowed funds and include a return of investor principal. Additionally, early redemption of shares is often very limited, and fees associated with the sale of these products can be high and erode total return.

"Confronted with a volatile stock market and an extended period of low interest rates, many investors are looking for products that offer higher returns in turbulent times. However, investors should be wary of sales pitches that might play up non-traded REITs' high yields and stability, while glossing over the lack of liquidity, fees and other risks," said Gerri Walsh, FINRA's Vice President for Investor Education.

Real estate investment trusts (REITs) pool the capital of numerous investors to purchase a portfolio of properties—from office buildings to hotels and apartments, even timber-producing land—which the typical investor might not otherwise be able to purchase individually. There are two types of public REITs: those that trade on a national securities exchange and those that do not. FINRA's alert focuses on publicly registered non-exchange traded, or simply non-traded REITs.

Public Non-Traded REITs outlines the features, complexities, risks and costs associated with non-traded REITs.
• Distributions are not guaranteed and may exceed operating cash flow. In newer programs, distributions may be funded in part or entirely by cash from investor capital or borrowings. Distributions can also be suspended for a period of time or halted altogether.
• Lack of a public trading market creates illiquidity and valuation complexities. Most non-traded REITs are structured as a "finite life investment," meaning that at the end of a given timeframe, the REIT is required either to list on a national securities exchange or liquidate. Many factors affect the valuation of non-traded REITs, including the portfolio of real estate assets owned, strength of the trust's balance sheet, overhead expenses and cost of capital.
• Early redemption is often restrictive and may be expensive. Most non-traded REITs place limits on the amount of shares that can be redeemed prior to liquidation. These limits can be as restrictive as 5—or even 3—percent of the weighted average number of shares outstanding during the previous year. Additionally, the redemption price is generally lower than the purchase price, sometimes by as much as 10 percent.
• Non-traded REITs can be expensive. State and FINRA guidelines limit front-end fees to 15 percent, but a 15-percent front-end fee on a $10,000 investment means that only $8,500 is going to work for an investor.

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August 24, 2011

Recovering Investment Losses in Desert Capital REIT

In June 2011, Desert Capital REIT was forced into an involuntary bankruptcy. Creditors with claims of over $43 million filed the petition to force the company into bankruptcy.

According to its website, Desert Capital was founded in 2003 and organized as a REIT with a goal to deliver attractive dividend income to investors through the acquisition of real estate loans and mortgage-backed securities.

Desert Capital REITs lost $21 million in 2007, $11 million in 2009, and another $26 million in the third quarter of 2010 alone. Desert Capital published a press release announcing it has "doubt as to ability to continue" and may have to be liquidated. In 2010, the Securities and Exchange Commission issued a subpoena to Desert Capital "pertaining to payments and transactions with related party, CM Capital." CM Capital and CM Securities are brokers that marketed the REIT and were operated by the same CEO as Desert Capital, Todd Parriott.

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June 1, 2011

FINRA Accuses Apple REITs/David Lerner Associates of Fraud

FINRA has accused David Lerner Associates of misleading investors by selling shares in illiquid real estate investment trusts, or REITs, to unsophisticated and elderly customers. According to FINRA, in soliciting customers for one investment known as Apple REIT Ten, Lerner provided misleading information that failed to show that distributions far exceeded income and were financed by debt.

The Apple REIT’s valuations did not change despite the downturn for commercial real estate, and Lerner “failed to sufficiently investigate the valuation and distribution irregularities” of the products.

Investors bought more than $300 million of shares in the $2 billion Apple REIT Ten offering this year, FINRA said in a disciplinary complaint. Lerner has sold almost $6.8 billion of Apple REIT shares to more than 122,000 customers since 1992, according to FINRA. Those sales have generated more than $600 million, accounting for 60 percent to 70 percent of the firm’s business since 1996. David Lerner Associates earned 10 percent on all the offerings of Apple REIT securities, as well as other fees.

The complaint is the first step in a formal proceeding, FINRA said. The firm can request a hearing before a disciplinary panel. In September, Lerner paid a $255,000 fine for failing to provide required information in connection with the replacement of variable life insurance policies and annuity contracts from November 1998 through February 2004, according to the New York State Insurance Department. A year ago, Lerner was accused by FINRA of overcharging customers on sales of municipal bonds and mortgage securities. That case is still pending, according to FINRA’s records.

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