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.
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