In many areas of the country real estate prices are once again on the rise, signaling a possible end to the downturn in the real estate crisis that has prevailed for the last few years. This optimism has resulted in new attention to investments vehicles crafted out of various forms of real estate holdings that carry risks that are not always clearly explained in the programs investment materials.
Undoubtedly wary of the risks inherent in these investments, and mindful of the investors who lost significant funds just a few years ago in real-estate related investments, the Finance Industry Regulatory Authority (“FINRA”) issued a newRegulatory Notice this month that sets out guidelines on “unlisted” real estate investment programs, such as unlisted real estate investment trusts (REITs) and unlisted direct participation programs (DPPs). These “unlisted” investments are ones that are not listed on a national securities exchange. The programs at issue invest in real estate and/or mortgages in real estate. In the former case, the program would actually own the building or other property. In the latter, the program owns the loans that are secured by property. These investments are called “unlisted” because they are not listed on a national securities exchange. As a result, there is a significant risk that investors will not be able to easily sell their investments should they need to do so because there is no public market.
FINRA’s Regulatory Notice seeks to address and correct what it deems to be misleading marketing materials. It stresses that disclosures must be “fair, balanced and not misleading”; for example, all risks related to the investments must be disclosed in the same size type as the potential benefits. Program materials must specify the source of any distributions – particularly any “guaranteed” distributions – and indicate if these distributions might include return of principal or even loan proceeds, and explain the factors, such as managerial discretion, that may affect future payments.
Among the detailed requirements, the notice reminds investment advisors that program materials must address market volatility, and may not promise stability, absent a sound basis to do so. The materials cannot selectively disclose the success of certain prior investments unless it discloses the returns of all related investments, including those that did not perform as well. Photographs of properties are forbidden unless they are actually owned by the specific investment being marketed or, if they are not owned by that investment, “prominent text” must explain that the pictured properties are similar to properties the investment will seek to acquire, or specify that the investment owns the mortgage associated with the property, not the property itself.
FINRA’s concerns are well-taken. One does not have to reach back far to remember the devastating impact on the economy resulting from the real estate crash a few years ago that created a ripple effect because many mortgages had been “securitized” in real estate investment vehicles marketed as “safe” and bearing high returns.
“I am sure that FINRA, with the new market optimism, is concerned that individuals not experience the financial devastation as they did a few years ago when the real estate market fell apart,” opined Marc A. Wites, a partner with Wites & Rogers, a firm that regularly represents investors who were misled by their investment advisors and/or investment materials. Mr. Wites stressed that “Investment advisors and brokers must fully explain the risks of these investments, including the fact that the value of the holdings may not offer liquidity, and is affected directly by the value of the underlying assets.” “Investors should review materials closely” he noted, “and if they have suffered losses, or are concerned about the liquidity of their investments, should consult with a lawyer experienced in this area.”
