For many financial consumers, the new rule changes requiring stockbrokers to provide more reliable pricing information for REITs (real estate investment trusts) and DPPs (direct participation programs) will be a case of "too little, too late." After the market crash of 2008, our securities law firm was inundated with inquiries from investors who had purchased non-traded REITs offered through real estate companies such as American Realty Capital, Berhinger Harvard, Inland American, KBS Real Estate-typically at a price of $10.00 per share. In many cases, the $10 per share price never changed from month-to-month, despite the fact that the real estate market was suffering catastrophic losses, giving investors a false sense of security about their REITs value.
Starting in April 2016, rule changes designed to better protect financial consumers will go into effect. Although the new changes won't put any restrictions on the sale of REITs and DPPs to financial consumers, the changes will require greater disclosure of the per share estimated value of the REIT or DPP. A summary of the rule changes is provided at the end of this blog post.
Investors Should Proceed With Caution When Considering a Non-Traded REIT Investment
While FINRA is taking steps to better protect investors, investors should still be careful and follow the tips FINRA has created for when an investor is considering unlisted REITs.
Investors should avoid putting their entire investment into one REIT or the same family of REITs because their initial investment is not guaranteed and may increase or decrease in value. Investing proceeds from one unlisted REIT to another should be carefully considered because it may only be in the best interest of the sales representative who receives a commission for the transaction.
- Investors should not base their decision to invest on the current distributions of an unlisted REIT because they are not guaranteed. REIT distributions can be suspended or stopped completely because they can be partially or entirely funded by cash from investor capital or borrowings.
- If an investor reinvests their distributions they should be aware that their reinvestments may be illiquid for a long period of time because they are subject to the same redemption policies as other investments.
- Getting money out of an unlisted REIT can be extremely difficult because the redemption policies can change at any time. Therefore investors that will want their money back in the near future should avoid unlisted REITs.
- As an investor do not rely on claims that an unlisted REIT is going public because the process is lengthy and may actually never happen. If the REIT does go public then the trade price could be less than its current valuation.
- It is in the best interest of older investors to not invest a large portion of their retirement income into an unlisted REIT.
Even though FINRA is taking steps to improve the transparency of unlisted REITs the investment itself has not changed and is still inappropriate for most conservative or moderate risk investors.
Overview of FINRA/NASD Rule Changes
 Financial Industry Regulatory Authority (FINRA) Rule 2310
To help increase the transparency of unlisted REITs FINRA amended Rule 2310(b)(5) to prevent any member from participating in a public offering of a REIT or DPP unless the issuer has disclosed three things:
- The DPP or REITs per share estimated value in the DPP or REIT periodic reports
- An explanation of how the value was determined; and
- The date of the valuation
The amended Rule 2130(b)(5) also requires the issuer of the DPP or REIT offering to include in each customer's account statement the per share estimated value that is based on the assets and liabilities of the DPP or REIT and determined by or with the help of a third party valuation expert. The issuer must also provide a written opinion or report explaining the scope of the review and the valuation method used.
 National Association of Securities Dealers (NASD) Rule 2340
The amendments to NASD Rule 2340(c) require firms to disclose how much money is taken out for fees and commissions for each investment by including them in the calculations of the share value. To calculate the new share value the amendment provides two different methods: a net investment approach or an appraised value method.
- Net Investment: Firms must disclose that part of a customer's distribution includes a net investment and that the net investment reduces the estimated per-share value on their account statement. The valuation is based on the percentage of the amount available for investment. If there is no amount available for investment provided then the firm must provide another equivalent disclosure.
- Appraised Value: The estimated per share value included in the Issuer Report is based on a valuation of the assets and liabilities of the unlisted REIT. These valuations must be done at least annually and by a third-party valuation expert using an approach that follows standard industry practice.
- Disclosures: To help address customer misunderstandings new Rule 2340(c)(2)(A) requires account statements that include a net investment to also disclose that part of the distribution includes a return of capital and that the return on capital reduces their estimated per share value. This requirement only apply to account statements that include a net investment where part of the distribution includes a return on capital.
New Rule 2340(c)(2)(B) require firms to disclose the nature of the REIT investment as well as the fact that the REIT is not listed on a national securities exchange, is generally illiquid, and the estimated value on the customer's statement may be higher than the price the customer actually receives for selling the security. These disclosures are required for all account statements that include per share estimated values for the REIT or DPP.