- September 14, 2020
Over the last two years, the Wolper Law Firm has received calls from dozens of clients, who purchased shares of non-traded real estate investment trusts (“Non-Traded REITs”) and non-traded business development companies (“BDCs”). Most of these clients purchased the Non-Traded REITs and BDCs between 2013-2016 with assurances made by Financial Advisors that they would receive stable dividends, principal protection and liquidity within 1-3 years. None of these assurances have come to fruition and, over the last two years, many of the Non-Traded REITs and BDCs have either suspended their dividends, lowered their dividends and/or experienced substantial price per share depreciation.
By way of background, Non-Traded REITs are securities that do not trade on a public securities exchange. For this reason, non-traded REITs can be illiquid. The underlying collateral of the REITs consists of income producing residential or commercial real estate. Typically, the commissions generated on non-traded REITs are higher than industry norm (approx. 7%) and the investments themselves may be subject to extreme volatility due to associated risk factors. Non-traded REITs are only suitable for investors with a long-term investment horizon, who are willing to accept higher levels of risk in their investments. The high commissions serve as an incentive for Financial Advisors to recommend these speculative investments.
Business Development Companies, or BDCs, are closed-end investment companies that help small companies meet their capital needs. The BDCs make loans to small businesses and finance those loans through capital raised from investors. Many BDCs do not trade on a public exchange and, consequently, are also highly illiquid.
Some of the most popular Non-Traded REITs and BDCs sold by brokerage firms across the country are the following:
• Global Net Lease REIT
• United Development Funding IV REIT
• Phillips Edison Grocery REIT
• Benefit Street Partners Realty Trust REIT
• Business Development Companies of America BDC
• Sierra Income Corp. BDC
• ARC NY Recovery REIT
• ARC Trust III REIT
• Healthcare Trust of America REIT
• ARC Realty Finance Trust REIT
• American Finance Trust (AFIN)
• ARC Global Trust REIT
• American Capital Agency Corp.
• American Realty Capital Healthcare Trust II
• American Realty Capital Retail Centers of America
• Carter Validus Mission Critical REIT
• FS Energy & Power Fund BDC
• FS Investment Corp. BDC
• Northstar Healthcare Income, Inc. REIT
• Hospitality Investors Trust, Inc.
• MVP REIT a/k/k the Parking REIT
Non-Traded REITs and BDCs also have high internal expenses, commonly known as middleman expenses, which dramatically lower the returns to investors. These fees, which can be between 12%-15%, erode the investment return. In order to overcome those high internal expenses, the Non-Traded REIT and BDC revenues have to remain sustainably high. Otherwise, returns are negatively impacted.
In 2020, the COVID crisis has disparately impacted Non-Traded REITs and BDCs, which have strong ties to the commercial real estate market. According to Nareit, “REIT sectors were disparately impacted by the pandemic and subsequent shutdowns, with sectors facing the most exposure to COVID-19 and related social distancing measures experiencing the greatest effect. The Lodging/Resorts sector, Retail sector, and Healthcare sector all reported declines. FFO decreased 25.0% and 16.7% in the Retail and Healthcare sectors, respectively, while FFO of Lodging/Resort REITs swung from slightly positive in the first quarter to negative $1.1 billion in the second quarter. Several sectors, however, saw FFO increases this quarter, including those sectors supporting e-commerce. Data Center REITs reported a 32.6% increase and Infrastructure REITs were up 3.8%. Specialty REITs, while not related to e-commerce, had an increase of 19.6% from the first quarter.”
Business closures, unpaid rent and the economic slowdown all contribute to increasing the price and dividend pressure on Non-Traded REITs and BDCs, which were already experiencing difficulties. Total dividends in the REIT industry have declined 16.8% and the trendline continues to move in a negative direction.
Financial advisors have a legal and regulatory obligation to recommend only suitable investments that are appropriate for their clients’ needs and objectives. Their employing brokerage firm has a legal and regulatory obligation to supervise the Financial Advisors’ sales practices and dealings with clients. To the extent any of these duties are breached, the customer may be entitled to a recovery of his or her investment losses. In addition, brokerage firms have a duty to conduct due diligence into the Non-Traded REIT and BDC issuers prior to recommending the investments.
The Wolper Law Firm represents investors nationwide in securities litigation and arbitration on a contingency fee basis. Matt Wolper, the Managing Principal of the Wolper Law Firm, is a trial lawyer who has handled hundreds of securities cases during his career involving a wide range of products, strategies and securities. Prior to representing investors, he was a partner with a national law firm, where he represented some of the largest banks and brokerage firms in the world in securities matters. We can be reached at 800.931.8452 or by email at email@example.com.