Alternative Investment

Regulators consider with rules for non-traded REITS

Now that a comment period for proposed rules for non-publicly traded Real Estate Investment Trusts has ended, groups representing brokerages and other parts of the industry are pushing home their fight against the potential changes. 

The North American Securities Administrators Association, which represents state securities regulators, stopped taking comments on Sept. 12 on its proposed statement of policy regarding Real Estate Investment Trusts, or REITs. In general, NASAA is seeking to ensure that brokers dealing in non-publicly traded REITs are abiding by the investment industry’s latest standards of conduct and that the net income and net worth thresholds used to determine who can invest in REITs are adjusted for inflation, among other things.

Opponents include industry groups such as the Institute for Portfolio Alternatives and Alternative & Direct Investment Securities Association, as well as representatives of large institutional investors like Blackstone. Their comments to NASAA generally express concerns that the proposed changes will lead to a hodgepodge of conduct standards from one state to the next, deprive investors of ways to diversify their portfolios and seek remedies for a problem that the industry has proved able to solve on its own.

The biggest worry for many is that NASAA’s statement of policy could be on a fast track toward adoption. NASAA is planning to hold its annual fall meeting from Sept. 18 to Sept. 20 in Nashville. Though no official agenda for its board’s business meetings have been posted, many in the industry worry the proposal on REITs could be discussed then and be up for a vote soon after. 

Andrea Seidt, NASSA Corporation Finance Section Committee chair, said reviewing the comments will most likely take weeks. 

“There were many comments submitted, with several good faith suggestions on ways to revise and improve the proposal that the committee is considering,” Seidt said in an email. “There is no firm timeline in place for this review. The policy is important, so it’s important for the committee and NASAA to get it right.”

How REITS work
Non-publicly traded Real Estate Investment Trusts are registered with the SEC and often have redemption restrictions that limit their liquidity. They are subject to IRS rules and are required to make regular SEC disclosures, including quarterly and yearly financial reports.

Non-traded REITs often come with minimum holding periods and are therefore not as liquid as publicly traded REITs. The minimum amount needed to invest in a non-traded REIT typically runs from $1,000 to $2,500, and the brokerage commissions and fees charged for managing them vary from company to company.

Anya Coverman, senior vice president of government affairs and general counsel at the Institute for Portfolio Alternatives, noted adoption of the proposal would follow quickly in many states on approval by NASAA.

“Approximately 10 states have some form of automatic adoption of NASAA policies into their state statute or corresponding regulations,” Anya Coverman, senior vice president of government affairs and general counsel at the Institute for Portfolio Alternatives, said in an email.

He added: “Even if a state were to decide not to incorporate the NASAA policy, that states’ investors could nevertheless become subject to another state’s most restrictive guideline.”

This isn’t the first time industry groups have shown signs they think the proposal is moving ahead too quickly. They previously complained that NASAA’s original 30-day deadline of Aug. 12 for submitting comments didn’t allow enough time for responses and successfully petitioned to have it pushed back a month.

Of the many criticisms submitted in the extended period, a large number take exception to NASAA’s proposal to apply the SEC’s Regulation Best Interest and other conduct standards to brokers and other entities dealing in non-traded REITs. NASAA contends the current standards are outdated. 

Critics, in contrast, argue that NASAA’s proposal is dangerously nebulous. It would apply to brokers dealing in non-traded REITs not only Reg BI but also whatever conduct standards might be in force in a particular state, either now or in the future. 

The lack of regulatory uniformity from state to state would “sow chaos in the compliance departments of regulated firms,” the Institute for Portfolio Alternatives wrote to NASAA in its comment letter.

“NASAA provides no explanation about how these various conduct standards would interact with one another or about the contours of the state requirements,” the institute says in the same letter. “The proposal would offer state administrators the ability to impose the conduct standards however the administrator pleases, under whatever facts the administrator chooses, without any expectation of consistency with the SEC, FINRA or other state administrators.”

Other proposals
In a separate proposal, NASAA calls for raising the net income and net worth thresholds used to determine who can invest in non-publicly traded REITs. Investors are now barred from putting money into non-public REITs unless they have a minimum net income of $70,000 along with a minimum net worth of $70,000; or a total minimum net worth of $250,000. NASAA contends these limits, meant to protect unsophisticated investors, should be raised to $95,000 and $340,000 to keep pace with inflation.

To critics, tighter thresholds will do little more than deprive investors of opportunities for diversification. They also note that non-publicly traded REITs provide sorely needed capital to projects like public housing.

Above all, they argue that NASAA’s proposals overlook changes the industry has been able to make on its own to prevent abuses. Critics of non-publicly traded REITs frequently point to data showing that people who invest in them would have done better had they instead put their money in a publicly traded real estate fund. 

Often-cited research by Craig McCann, a former academic and founder of SLCG Economic Consulting, found that investors in 140 non-traded REITs made $59.2 billion less from their investments than if they’d put their money into publicly traded REITs. The difference largely came down to higher fees charges on non-traded REITs and conflicts of interest.

Defenders of the industry contend such criticisms fail to distinguish between older, “lifecycle” REITs and new net value added REITs, or NAV REITs. Lifecycle REITs tend to be illiquid, allowing investors to reclaim their money only after a fund has reached the end of its lifecycle and is sold, merged with another fund or listed on an exchange. NAV REITs, in contrast, are designed to last into perpetuity and allow investors to cash in as much as 20% of the total outstanding share in a given year. Industry groups argue they also tend to have lower fees and more-transparent commission and fee structures.

NAV REITs first became common in 2017, when large institutions like Blackstone began offering them. Now they dominate the industry.

In a comment letter, Kevin Gannon, president and CEO of the real estate investment bank Stanger & Co., reports that nearly $19.4 billion was invested in older “lifecycle” REITs as recently as 2013. By 2021, that number had fallen to $11 million. Meanwhile, the amount of investment in NAV REITs had risen to nearly $36.5 billion, according to Gannon. NAV REITs now account for 99.9% of all the capital raised by non-traded REITs, Gannon said, citing data gathered from SEC reports and direct communications with institutions like Blackstone.

NASAA’s proposal for regulating non-traded REITs contains two further provisions. One calls for a “concentration limit” that would prevent dealers from putting more than 10% of an investor’s liquid net worth in a non-traded REIT. The other would set limits on institutions’ ability to take money intended for investment in real estate through a non-traded REIT and use it to pay cash distributions back to investors.

Critics contend both proposals would either further deprive investors of diversification opportunities or unnecessarily complicate dealers’ and brokers’ management of non-traded REITs.

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