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'Not priced' REITs rattle Lerner clients

Investment News

Clients of David Lerner Associates Inc. holding shares in nontraded REITs created by Apple REIT Cos. Inc. received account statements at the end of last month in which the longtime value of the shares was shown as “not priced.”

For years, shares of the real estate investment trusts were listed at $11 on client account statements. The firm continued to list the same price after the Financial Industry Regulatory Authority Inc. in 2009 told broker-dealers to adjust prices on the investments more frequently.

Finra also prohibited broker-dealers from using information more than 18 months old to estimate the value of a nontraded REIT.

At the end of May, Finra filed a complaint against David Lerner, alleging that the firm was misleading investors and marketing unsuitable investment products to them.

Finra spokeswoman Nancy Condon declined to comment on the firm’s change in account pricing.

Since 1992, David Lerner has recommended and sold nearly $6.8 billion in Apple REIT shares, according to Finra.

“There have been some questions from investors” about the change of the value of the REITs shown on account statements, said Joseph Pickard, senior vice president and general counsel with David Lerner, which is based in Syosset, N.Y.

When asked if investors are anxious about the change, he said, “I can’t answer that.” Client account statements also show the cost of investment in the Apple REITs, which is either $10.50 or $11 per share.

Mr. Pickard said there was “no particular reason” for the change, but added that the recent “stir and hoopla in other people’s minds” about the REITs’ estimated market value contributed to the firm’s decision to make the change.

The firm is “absolutely” in compliance with Finra rules and regulations when selling the product, Mr. Pickard said.

The account statement change made by the Lerner firm “is causing serious concern for investors,” said Jake Zamansky, a plaintiff’s attorney, who added that his firm, Zamansky & Associates, has spoken with up to 50 David Lerner clients. “People are really looking for clarity here.”

A broker-dealer switching a security’s value to “not priced” isn’t unheard of, but it is far from ordinary, attorneys said. Although some attorneys noted that such a change could be a bad harbinger for any security, another lawyer said that such a price change is a potential step in the right direction.

“The price of $11 per share is most likely a misrepresentation of its true value, which is almost impossible to ascertain and price,” said Phil Aidikoff, a plaintiff’s attorney who has been following the David Lerner case but has no investors with the firm as clients.

“Issues of pricing have been going on for a long time in the securities business,” Mr. Aidikoff said.

Having nontraded REITs listed as “not priced” on client account statements is not “systemic,” said Kevin Hogan, executive director of the Investment Program Association, a trade group that includes nontraded REITs and the broker-dealers that sell them. He added that he had “no idea” whether any other REITs have recently made such a change on client account statements.

Finra’s complaint against David Lerner has renewed concerns among broker-dealers about the sales of illiquid investments such as nontraded REITs and private placements.


A few small nontraded REITs recently have made disclosures revealing problems, or at least the potential for problems, with investments, broker-dealer executives said.

In addition to problems with investments, some smaller REITs may be having a hard time gaining traction with broker-dealers because firms are looking to product sponsors to educate advisers and their clients, said Nicholas Schorsch, CEO of America Realty Capital, which sponsors five nontraded REITs.

Before the credit crisis in 2008, nontraded REITs could be successful simply by showing up, he said. With anxiety running high among investors and broker-dealer executives due to problems with some of the products and the market in general, that way of doing business has changed, Mr. Schorsch said.

“The market is getting more difficult. Just because you get to the table doesn’t mean you get to play,” he said.

The number of nontraded-REIT products has exploded since 2000, practically quadrupling to 45, noted Jeffrey Hanson, CEO of Grubb & Ellis Equity Advisors LLC.

“There’s saturation with all the new entrants, and barriers are very real and high,” he said. New nontraded REITs need to raise $15 million to $20 million a month to work, and many simply can’t reach that level.

“If you can’t get to $20 million, you’re going to have further shutdowns,” he said.

Problems at smaller nontraded REITs – those that have raised less than $50 million – have caught the attention of the SEC and Finra, which are scrutinizing the popular products sold exclusively through independent broker-dealers.

Around the same time that Finra filed its complaint against David Lerner, several nontraded REITs reported real or potential difficulties.

For example, Desert Capital Real Estate Investment Trust Inc. in April filed for bankruptcy protection, and at the end of May, Todd Parriott, its chief executive, resigned.

Also in April, a member of the board and chairman of the compensation committee resigned from Hartman Short Term Income Properties XX Inc., a nontraded REIT. After the resignation of the director, Larry Bouffard, the company’s board authorized the REIT to consider buying pieces of a related REIT, Hartman Short Term Income Properties XIX Inc.

Meanwhile, this month, Bluerock Enhanced Multifamily Trust Inc., which last year pulled its REIT from the market, said that an affiliated broker-dealer, Bluerock Capital Markets LLC, will assume the managing and distribution for its initial public offering.

Sudden changes in a REIT’s board or the broker-dealer that sells the product, or the purchasing of properties by one REIT from another related REIT, are indicators that broker-dealers and registered representatives need to pay careful attention to the investment, industry observers said.

“When we see something like this, it raises eyebrows and we’ll look into it further,” said Jeff Young, senior vice president with First Financial Equity Corp., a broker-dealer with 125 affiliated reps.

Problems with nontraded REITs often occur off the radar, he said.

The firm has selling agreements with both the Hartman XIX and Hartman XX REITs but passed on selling agreements with the Desert Capital and Bluerock REITs.

“Hartman is a good company, and the properties are good properties,” Mr. Young said.

But First Financial Equity has become “very restrictive” with its selling agreements for investments such as nontraded REITs and private placements.

Mr. Young said that the nontraded-REIT industry does have potential conflicts of interest, particularly if a sponsor of the REITs has more than one program.

First Financial Equity has become more restrictive with the products that it sells just as the industry continues to mushroom, he said.

“I don’t have time to talk to all the REIT wholesalers that are knocking on our door,” Mr. Young said.

Executives from the three nontraded-REIT sponsors stressed that the changes were due to market conditions or a normal part of the business.

Finra hasn’t filed actions against broker-dealers related to the sale of those three sponsors’ REITs.

Desert Capital REIT spokeswoman Carrie Cook attributed her firm’s bankruptcy filing to the effect the credit crisis had on real estate in Las Vegas and elsewhere in Nevada.

Allen Hartman said that the changes revealed in April SEC filings by his firm – which owns about $400 million in real estate, mostly in Texas – were a normal part of doing business and were unrelated. He said that he asked Mr. Bouffard, 78, to resign from the board due to his age.

The two REITs bought properties together, and the Hartman XX REIT is buying up the assets of Hartman XIX based on pricing done by an independent third party and approved by the independent board.

R. Ramin Kamfar, owner and chief executive of Bluerock, said that the broker-dealer switch was necessary because the first firm did a poor job selling the product.

The firm’s own wholesalers began selling the fund last week, Mr. Kamfar said.