David Lerner’s Apple REIT Party Is Coming To An End; Nontraded REITs Are Put on Notice by SEC

Today’s Wall Street Journal article reports that the “Securities and Exchange Commission is intensifying its scrutiny of the booming business of real-estate investment trusts that aren't traded on a stock exchange.”

WSJ reiterates that FINRA already has brought charges against David Lerner Associates Inc., for “misleading investors and marketing unsuitable products to them. “  Specifically, WSJ reports:

The Financial Industry Regulatory Authority said the Syosset, N.Y., firm targeted elderly and unsophisticated customers as it marketed a $2 billion real-estate fund. Finra said the firm provided "misleading" information about the REITs on the firm's website. Finra also said the firm should have conducted more due diligence on the company that manages its real-estate funds, some of which have been paying out returns greater than the amount of cash actually generated by those funds. The claim is still pending.

Further, WSJ reports that “other firms that run nontraded REITs are trying to distance themselves from sales techniques used by Mr. Lerner.”  In addition to sales seminars offering door prizes, WSJ cites that, “Other REITs point out that they are sold through numerous financial advisers, while Apple REITs are sold exclusively through David Lerner.”

Now, the SEC is investigating.  WSJ reports that “the SEC wants to know more about how nontraded REITs operate and what they disclose to investors after closing the fund.”  Indeed, an SEC lawyer is quoted as saying, "We believe investors would benefit from more information about how [nontraded REITs] reach their valuations.  We told the industry we would be reviewing the annual reports for this disclosure, and if it doesn't appear, they should expect to hear from us."

Of particular concern to David Lerner Associates and its Apple REITs, WSJ reports that “U.S. securities regulators are instructing managers of such real-estate funds to specify how they arrive at their valuations.”  WSJ observes that “some nontraded REITs keep their share prices relatively constant even though the value of the underlying properties they own might have

Likewise, WSJ reports that:

Such REITs routinely report share prices in statements to investors but don't make it easy for investors to get their money back. Of the nontraded REITs launched since 1990, just 13 have returned investors' capital through mergers or acquisitions, with four through listing on a public stock exchange, while two liquidated.

Apple REITS in particular have suffered from this fatal flaw.  For example, Apple REIT 6 has been unable to find a buyer.

 Finally, WSJ describes how some REITs like Apple REITs “often don't generate enough cash flow from the properties, at least initially, to cover annual payments to investors.”  WSJ quotes a REIT industry analyst as saying, "Borrowing to pay a dividend is a concern.  You have to wonder how sustainable that business model is."