FINRA Proposes Rule Addressing Valuation Issues of REITs and DPPs

FINRA has recently proposed a rule change that would amend the procedures for valuing Direct Participation Programs (DPPs) and Real Estate Investment Trusts (REITs).  The rule change is intended to provide greater clarity to investors concerning the value of these investments, an extremely contentious issue.

A REIT is a security that invests in different types of real estate such as commercial properties, home mortgages, or other specialty niche real estate markets (e.g., golf courses, malls, hotels). REITs can be publicly traded or privately held.  Publicly traded REITs can be sold on an exchange and have the liquidity traditional associated with other liquid stocks and bonds.  Non-traded REITs are sold only through broker-dealers and are illiquid.

Increased volatility in the stock market in recent years led some investment advisors to increasingly recommend REITs as a purported stable investment during unstable times.  However, claims of stable REITs have been shown to be false.  The stability of non-traded REITs only exists because brokerage firms and issuers have control over the value of the security listed on an investor’s account statements and not because the security will actually sell at that value or is stable over time.

The non-traded REIT industry sales doubled last year to $20 billion, from 2012.  Some within the industry worry that a change in per-share valuation disclosures would hurt sales of nontraded REITs.  However, FINRA’s rule proposal is a step in the right direction to end the practice of listing inaccurate values for REITs.  The FINRA rule change would give investors a truer picture of the value of the REITs by including the costs and commissions into the share value of the REIT.  If approved, the rule change, will eliminate the practice of broker-dealers to list the per-share value of non-traded REITs at $10, or the sales price

Instead, FINRA’s rule change would force firms to take into account the various fees and commissions paid to brokers and dealer managers and reduce the share price on each customer account.  Many investors are unaware that anywhere from 8-12% of their total investment goes to other parties and not toward investment purposes.  Yet, at present, that 8-12% is listed on account statements as being invested in the REIT.

Brokers interviewed about the proposal fall on both sides of supporting and opposing the rule change.  According to an InvestmentNews article, an adviser with Ameriprise Financial Services Inc. was quoted as stating “I never thought it made sense to show $10 per share from beginning, because it gave the impression that the valuation was always the same.”

The other investment methodology that can be chosen is an independent valuation.  An independent valuation could be used at any time for listing the value of the security and would consist of the most recent valuation disclosed in the issuer’s current reports and would be supported by a third-party value expert’s determination.

The attorneys at Gana LLP are experienced in investigating claims concerning the sale direct participation programs and REITs.  Our consultations are free of charge and the firm is only compensated if you recover.