Fundraising by nontraded real estate investment trusts (REITs) has tripled since 2009 — rapid growth that has led regulators in several states to push for restrictions on the industry, The Wall Street Journal reports.
Previous reports indicated that nontraded REITs would play an integral role in shaping the senior housing merger and acquisition landscape this year.
Such nontraded REITs as Griffin-American Healthcare REIT II and CNL Healthcare Properties made multimillion-dollar deals this year, before Griffin-American Healthcare REIT II was acquired earlier this month by publicly traded NorthStar Realty (NYSE:NRF) for $4 billion.
While the publicly traded “Big-Three” REITs — HCP, Inc., Ventas and Health Care REIT — generally have a lower cost of capital than nontraded REITs, these nontraded REITs have the ability to make acquisitions without first having to line up financing, which some investors in the senior housing space believe to be a key force driving their growth.
But the North American Securities Administrators Association (NASAA), which represents state securities regulators, plans before the end of the year to propose guidelines that, if adopted, would significantly change the way nontraded REITs are sold and managed.
These guidelines focus primarily on the investments, including those that would limit how much of an individual’s net worth could be put into any single REIT and curtail the ability of REITs to pay distributions to investors, primarily through dividends, immediately after raising money from shareholders.
The REITs must pass along at least 90% of their income to shareholders in the form of dividends. Sales have skyrocketed in the last five years, with investors attracted by dividends of 6% or higher and share prices that stay relatively stable. Investors typically aren’t able to sell their shares in the company until an event such as a sale, merger or listing of the whole company takes place.
These nontraded REITs have been investigated by regulators, including the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission, for inadequate disclosure of risks and their high fees, which typically range from 12% to 15% at the time of sale. Some state regulators also are concerned that many funds start to pay dividends to investors immediately, using money raised from investors, rather than from the operating profits of their real estate portfolios.
“They borrow from the pot at the beginning, but they make up for it at the end,” said Dan Matthews, a lawyer with the Washington state securities regulator who worked on designing the proposed guidelines. “It’s something that makes us nervous.”
States typically adopt NASAA’s recommendations, and those that do can fine or take other administrative actions against REITs that don’t comply, such as revoking a license to issue securities, WSJ reports. The regulations also indirectly affect independent brokers, by opening them up to enforcement actions from state legislators if they don’t follow guidelines.
Industry officials haven’t officially responded to the specific draft guidelines. But Kevin Hogan, chief executive of the Investment Program Association, which represents both nontraded REITs and the independent broker-dealers who sell their shares, told the WSJ the industry has had “productive, open and candid” discussions about the proposals and that it supports any changes that make these investments more transparent.
“I think [NASAA] is aligned with us in that capital formation and job creation in their states is important,” Hogan said. “They open up shopping malls and open up office buildings, and that creates jobs, and that’s what these are all about … protecting and informing investors is critical.”
Read the full Wall Street Journal article here.
Written by Emily Study