Real estate investment trusts (REITs) can be phenomenal ways to invest. They let you
- buy into commercial, income-producing properties;
- earn a return; and
- receive dividends.
All without having to purchase and manage your own properties, which could be a full-time job.
However, while publicly-traded REITs are highly regulated, the privately held, non-traded ones aren't. Investment fraud and scams can happen in either type, but are more likely in non-traded REITs.
Scams come in many forms. A manager might make offer a non-traded REIT with the intention to defraud people, or the scam could involve making a legitimate offering and then mishandling funds or misrepresenting earnings later.
Be vigilant and informed to avoid these scams -- here are some considerations and tips to stay safe before purchasing shares:
Check with the SEC
Many publicly and privately owned REITs are registered with the Securities and Exchange Commission (SEC). The SEC advises investors to beware of REITs that aren't registered. To verify the registration of a REIT you’re interested in, research it in the SEC’s EDGAR system.
You’ll also want to research the broker or individual selling the REIT using the Financial Industry Regulatory Authority’s BrokerCheck database. See if the broker is registered to sell securities or offer investment advice and whether he or she has been subject to any regulatory actions or complaints.
Ask for as much detailed information as possible
The REIT you're considering should provide historical performance data and information about properties it owns. Detailed information should be available online on both the offerer and the opportunity. If neither you nor your broker can find it, this is a red flag.
Although non-traded REITs may seem more attractive because of their higher returns and dividend yields, it’s not umcommon for them to borrow to fund those distributions, sometimes using investor money. Consequently, distributions could stop or be suspended at any time. Find out how the REIT is paying investor dividends—borrowing to do it dilutes the value of the shares and funds available to reinvest in new properties.
In 2018, three REITs reached an $8.2 million settlement with the SEC for failing to tell investors they couldn't meet their distribution obligations. The Houston brokerage firm involved was ordered to pay $1 million to investors on the basis that it had helped those REITs commit fraud.
Make sure you understand the fee and management structure. Non-traded REITs often pay very high manager fees based on the value of assets they manage, which can affect the amount that investors take home. There can also be high upfront fees of over 10%.
Non-traded REITs are often highly illiquid, sometimes locking investors into 10-year deals. That means you can't sell for long periods of time, so it's important to know the timeframe of the contract before you commit.
If these things are apparent in the prospective REIT and they aren’t appealing to you, or you cannot get the information you need, you probably shouldn't buy it.
There are several exchanged-traded REITs with attractive dividends and lower fees that likely won’t carry these kinds of risks.
Engage a securities attorney
If you’re thinking of investing in a privately held REIT, engage a securities attorney to review the offer documents before you sign. Search for these securities attorneys via your local American Bar Association directory or on sites like FindLaw.
Prevent, prevent, prevent
The best way to deal with a scam is to never buy in. Once you’ve done so, many brokerage contracts require arbitration, an expensive legal remedy that prevents you from taking your grievance to court. Make sure you do your due diligence before it gets to that stage.
Like many things, if a REIT scam sounds too good to be true, that’s usually because it is.