State Securities Regulators Consider Rules Affecting Nontraded REITs
September 1, 2022 | James Sprow | Blue Vault
The North American Securities Administrators Association (“NASAA”) is considering new policies that would establish limits on how much an individual can invest in nontraded REITs. Even though fund documents describe the risks and fees associated with the nontraded REIT products, NASAA says nontraded REIT strategies aren’t always appropriate for the small investors who typically buy their shares.
As quoted in a recent Wall Street Journal article, Andrea Seidt, Ohio securities commissioner and chairwoman of NASAA, said “The product structure poses a unique risk for unsophisticated investors.”
Nontraded REITs are one of the ways for individuals to get direct exposure to some types of commercial real estate, including office complexes, industrial warehouses, shopping centers, hotels, and healthcare properties. Nontraded REITs raised an industry record $35.7 billion in 2021 according to Blue Vault, and raised $12.2 billion in the first quarter of 2022.
Over the last five years, nontraded REIT programs have evolved into continuously offered NAV REITs that report their net asset value per share monthly, and in some cases daily. These newer programs also offer quarterly redemptions of up to 5% of their outstanding shares at the most recent net asset value, greatly improving the liquidity available to shareholders. Along with the greater levels of transparency and liquidity, the NAV REITs have reduced their upfront fees, offering retail investors share classes with selling commissions and dealer manager fees approximately half of those charged by the traditional life cycle REITs that were the norm before 2017.
Blue Vault reports quarterly on the share redemptions made by the NAV REITs. For example, Blackstone REIT, by far the largest nontraded REIT with $130 billion in total assets as of June 30, 2022, has redeemed outstanding common shares at an average rate of 1.1% per quarter since its inception. Starwood REIT, the second largest of the NAV REITs with $26 billion in total assets as of June 30, 2022, has redeemed an average of 0.4% of outstanding shares per quarter since its inception in 2019. Given the redemption policies of these REITs that allow investors to redeem shares at their net asset values, liquidity and transparency have improved significantly.
Fund sponsors, brokers and financial advisers have already addressed NASAA’s concerns. The WSJ quoted Anya Coverman, senior vice president of the Institute for Portfolio Alternatives, a trade organization that represents the nontraded REIT industry, “It is in many ways a solution in search of a problem.” Competition within the industry to create products that meet the needs of investors by offering access to a wide range of alternative investments related to commercial real estate has already solved the problems that NASAA cites.
NASAA is a voluntary organization of North American regulators that has no power on its own to change regulations. But many state regulators adopt the association’s recommendations. It now is taking comments on its proposed regulations from industry participants.
Kevin Gannon, CEO of Robert A. Stanger, is quoted by the WSJ as saying that if the association approves the policies and they are adopted by most states, fundraising by nontraded REITs could be reduced by more than 20%.
One of the new provisions in NASAA’s proposal that has potential to impact newer nontraded REIT programs is to prohibit the paying of distributions from capital raised by selling shares. Given the time required to raise a sufficient level of equity to build a commercial real estate portfolio, it has been common in the past for distributions paid in the first few quarters of a nontraded REIT’s life cycle to be funded in part by its sale of shares. If the new regulation were adopted, new fund sponsors would have to provide upfront capital sufficient to provide distributions until the REIT achieves a scale and cash flow that can cover distributions. Otherwise, investors in new funds would be incentivized to wait until later in the offering period to invest. This would present a potential “chicken or egg” dilemma for new REIT programs. Distribution income is an important feature of nontraded REITs that make them attractive to investors.
Another controversial proposal is a concentration rule that would limit investors from putting more than 10% of their liquid net worth in a nontraded REIT and other investments offered by the REIT sponsor. Industry officials say the proposed concentration limit would apply an unfair one-size-fits-all standard to all investors. (It is interesting that concentration limits are being proposed for a particular investment category, singled out for restrictions, while other investment types do not face such limits.) Such decisions should be made by investors and their broker-dealers or financial advisers, Ms. Coverman said.
Sources: WSJ, Blue Vault
