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Should My Broker/Dealer Have Sold Me Non-Traded REITs?

Non-traded REITs can be tricky, confusing investments. Although they can generate distributions, they also come with unique and hard-to-discern risks. Following a major downturn of the market in 2008, the non-traded REIT industry took a nose dive.

Investing largely in commercial real estate, many of the biggest non-traded REITs — including Behringer Harvard REIT I, Inland American Real Estate Trust and Inland Western Retail Real Estate Trust — slashed distributions or drastically limited their redemption programs. Recently, many investors have filed formal complaints against various broker/dealers who sold them shares in non-traded REITs. Most of the allegations involve misrepresentation and undisclosed risks and characteristics of the investments.

If your stockbroker sold you non-traded REITs without warning you about the risks or the high fees associated with the investment, he or she can be held liable for your loss.

A New Twist on REITS

Mihalek Law is investigating a new twist on REIT's - non-traded, preferred stock in real estate companies. One such company, Preferred Apartment Communities, Inc. ("PAC" or the "Company") is in the process of offering 1.5 Million shares of its non-traded, preferred stock for
$1,000 per share. The Prospectus for the non-traded, preferred stock provides that the holders will receive a 6% annual "dividend" on the shares. a review of the Company's financials indicates that PAC has suffered losses the last several quarters, so one must wonder how secure those hefty "dividends" are, or whether they are "dividends" at all. The Prospectus offers some insight. It provides that if the Company does not have enough cash from operations to fund the distributions (and historically it has not) the Company "may borrow, issue additional securities or sell assets in order to fund the distributions." PAC Prospectus dated March 16, 2017, page 54.

As with its non-traded REIT cousins, there are substantial fees and expenses associated with the preferred shares. The Prospectus discloses that of the $1.5 Billion of gross sales proceeds, one-hundred seventy-two Million, five hundred Thousand - that's right 11.5% (7% commission) goes to the salesmen, (3%) the affiliated dealer manager, and another 1.5% to pay "other offering expenses." Right from the start, only $885 of each $1,000 share is available to invest. Wait, it gets worse.

The affiliated manager is entitled to receive various management fees and expenses from the Company which are capped at 2% of the total value of the Company's assets each year. The Company intends to invest the $1,327,500 ($1.5 Billion less $172 Million offering expenses) in $3.6 Billion of real estate. Therefore, the Company intends to borrow nearly two dollars for every dollar it raises, which makes the investment very risky. 2% of $3.6 Billion is $72,000,000 which is nearly 5% of the total $1.5 Billion offering. These are annual, reoccurring expenses. It appears that the only clear winner is the Company and its affiliates!

To make matters worse, the preferred shares are not traded, they are illiquid.
The Prospectus discloses that the holders of the preferred shares may redeem them, i.e., sell them back to the Company, but there is a catch, or more accurately, a cost. If the shares are redeemed in the first year after purchase, the redemption penalty is 13% - that's a whopping $130 per share! If investors want to sell back their shares in years two or three, the redemption penalty is 10%. The redemption penalty drops to 5% and then 3% in years four and five, respectively, and then disappears all together.

If a person holding the preferred shares dies within two years of issuance, then the Company will redeem the shares for $1,000 per share, less all dividends previously paid to the holder or the estate. Moreover, the Company has the right, in its sole discretion, to pay the redemption price in cash or in equal value of its common stock.

Lastly, the Prospectus contains the following caveat regarding a holder's right to redemption: The Company's obligation to redeem any of the shares of preferred stock is limited to the extent that we do not have sufficient funds available to fund any such redemption. If funds are not available to buy back the shares, the Company does not have to honor the redemption request.

One must contemplate where the funds would come from to buy back shares since the Company has suffered operating losses for the past several quarters. Like the funding of distributions, perhaps by selling additional shares to new investors!

In our view, this new investment twist, like Non-Traded REIT's, are structurally flawed investments and unsuitable for retail clients. Call us if you were sold any of these non-traded products to see if you can recover your damages.

Get Help From An Experienced Lexington Legal Team

In order to build a winning case, it's critical to work with an experienced team of lawyers. The attorneys of Mihalek Law have been representing investors in Kentucky and across the country in securities arbitration and litigation for more than 50 years.

Who Benefits From Non-Traded REITs?

Unlike their publicly traded counterparts, non-traded, or unlisted, REITs are illiquid, high-commission investments. The operators of non-traded REITs dictate when investors can redeem their shares, if ever, and for what price.

The product raises money for real estate purchases by selling shares to investors via broker/dealers and investment advisers. In turn, the broker/dealers collect hefty commissions. When all is said and done, fees and commissions can eat up to 15 percent of an investor's principal before the REIT purchases the first piece of real estate — that's a pretty big loss to overcome from the outset!

So why does your financial adviser recommend a non-traded REIT? It's the 7-9 percent commission. Think of it. You spend 10 minutes with your trusted adviser who recommends that you invest $100,000 in a non-traded REIT. He earns 7, 8 or $9,000 immediately and your investment immediately suffers a 10-15 percent loss when all the offering expenses are tallied. What a deal! Non-traded REITs are rarely a good choice for investors.

Contact Us If You Were Misled By A Stockbroker Or Financial Adviser

If you believe that you have been misled by your stockbroker or financial adviser, contact our attorneys to schedule a free consultation. We can be reached through our contact form or by calling 800-783-1413.