Help Recover Losses for Non-Traded REITS and Oil and Gas Investments
Real Estate Investments Trusts (REITs) Can Be Public or Private.
The attorneys at Israels & Neuman can help recover investment losses for non-traded REITS and oil and gas investments.
Many people are aware of the real estate bubble that ran up real estate prices in the first half of the 2000’s decade but saw prices crashing in 2007-2009. Wanting to get in on the real estate boom, many advisors recommended that their customers invest in REITs (or Real Estate Investment Trusts). A REIT is a company that owns multiple (sometimes several hundred) pieces of real estate, usually income-producing real estate. Investors then can purchase shares of the REIT company, hoping to get income generated from the underlying real estate.
Investors can purchase publicly traded REITs, which are available to be bought and sold on a nationally recognized securities exchange like the NYSE or NASDAQ.
Investors can also purchase REITs which are not available on a publicly traded exchange and are referred to as non-traded REITs (or private REITs). Unfortunately, non-traded REITs are fraught with issues that investors are not typically aware of.
Dangers of Non-Traded REITS
Dangers of Non-Traded REITS.
- Illiquidity
- Hard to Sell: Non-traded REITs are not listed on public exchanges, making it difficult, if not impossible, to sell shares before the REIT’s liquidity event (such as listing on an exchange or selling assets). This can mean locking up your capital for years, often without the flexibility to sell shares quickly if you need access to your money.
- Redemption Restrictions: Many non-traded REITs have restrictions on redemptions, limiting how and when investors can sell shares. Redemption programs are often limited, can be suspended, or may involve penalties.
- Lack of Transparency
- Opaque Valuations: Because non-traded REITs aren’t publicly traded, it can be difficult to know the true value of your investment. They are typically revalued infrequently, and the prices are based on estimates rather than daily market prices.
- Information Asymmetry: Non-traded REITs may offer less frequent or less detailed financial reporting compared to publicly traded REITs, making it harder for investors to evaluate performance.
- High Fees and Commissions
- Upfront Fees: Non-traded REITs often have high upfront fees, which can range from 10% to 15% of the investment. These include broker commissions, offering fees, and management fees. These costs immediately reduce the amount of your investment.
- Ongoing Management Fees: Non-traded REITs typically charge ongoing asset management fees, property management fees, and performance-based fees, which can further erode your returns.
- Dividend Sustainability
- Return of Capital vs. True Income: Some non-traded REITs pay dividends that may include a return of capital, meaning the payout is coming from the investor’s own money rather than actual profits generated by the REIT. This can mislead investors into believing they are receiving higher returns than they really are.
- Suspension of Dividends: If the underlying properties or investments perform poorly, the REIT may suspend or reduce dividend payments, which can negatively impact expected returns.
- Market Risk
- Economic Sensitivity: Like other real estate investments, non-traded REITs are sensitive to market conditions, interest rate changes, and economic cycles. Poor market conditions can lead to reduced property values, lower rental income, or difficulty in selling assets at favorable prices.
- Concentration Risk: Non-traded REITs may invest in a specific sector or geographic region, increasing exposure to localized risks, such as an economic downturn or oversupply in that area.
- Potential Conflicts of Interest
- Sponsor and Management Relationships: The sponsors and managers of non-traded REITs may have conflicts of interest, such as receiving fees for property acquisitions, financings, or management that are not necessarily aligned with shareholder returns. This can lead to decisions that benefit the sponsor more than the investors.
- Long-Term Horizon
- Extended Time Before Liquidity Event: Investors in non-traded REITs may have to wait 5–10 years or longer for a liquidity event, such as a sale of assets or an initial public offering (IPO) of the REIT. During this time, your capital is locked up, and there’s limited ability to exit the investment.
- Tax Implications
- Complex Tax Treatment: The tax treatment of dividends from non-traded REITs can vary. Some portion of the distributions might be treated as ordinary income, which is taxed at a higher rate than qualified dividends. Additionally, depreciation on real estate holdings can complicate the tax treatment of distributions.
- Risk of Underperformance
- Poor Investment Decisions: Non-traded REITs can underperform if their management makes poor acquisition decisions, overleverages the portfolio, or fails to maintain properties, all of which can negatively impact your returns.
- Leverage Risks: Many non-traded REITs use debt to finance property acquisitions. Excessive leverage can amplify your losses during downturns or periods of rising interest
Are Commissions on Non-Traded REITS Paid to Advisors?
Non-traded REITs have massive sales commissions compared to other investments, which benefits the advisors as well as high fees, often running as high as 15%. This has driven the sales of non-traded REITs to approximately $12 billion a year. Unfortunately, non-traded REITs have the largest commissions of any product that a financial advisor could sell. The sales commissions, fees, and offering expenses for a non-traded REIT typically amounts to 15% to 20% of the amount invested. It is comparable to driving a new car off the lot and immediately having 15% depreciation.
In addition to the upfront commissions of 9% to 12% percent paid directly to the broker (with the rest going to the REIT manager), there are individual property/asset acquisition fees of up to 2.75%, property financing fees of up to 1%, management fees of up to 5%, disposition fees of up to 1%, and asset management fees of up to 1% per annum, plus additional expenses. The net result is that out of a $100,000 initial investment, only about $80,000 to $85,000 would be left to actually invest. These massive fees create a commission vortex that caused sales of non-traded REIT shares and purchases of the underlying property at almost any price regardless of the quality. Unfortunately, many investors have no idea how expensive these investments truly are.
Financial advisors often pitch these investments to elderly, conservative investors, representing that the returns of these non-traded REITs are stable. They have also pitched these investments to their clients as being non-correlated to the stock market. However, like many investments, non-traded REITs can lose value (sometimes significant value) if the underlying real properties suffer losses or are foreclosed on.
What are Oil and Gas Investments?
Other high-commission products are oil and gas exploration investments. Oil and gas limited partnerships (LPs) can offer attractive tax benefits and potential for high returns, but they also come with significant risks. Here’s a breakdown of the primary dangers associated with these types of investments:
High Risk of Loss
- Volatile Commodity Prices: Oil and gas prices are highly unpredictable, influenced by global supply and demand, geopolitical events, and environmental factors. This price volatility can drastically impact the profitability of oil and gas projects.
- Exploration and Production Risks: Drilling for oil and gas is inherently risky. Exploratory wells may not yield profitable resources, leading to a total loss of the investment in some cases.
Illiquidity
- Limited partnerships are typically long-term investments that are not easily bought or sold. Unlike publicly traded stocks or funds, there’s often no active secondary market for LP units, making it hard to exit the investment.
Complex Tax Considerations
- K-1 Reporting: Investors in oil and gas LPs receive a Schedule K-1 for tax purposes, which can complicate tax filings. It often arrives late in the tax season, potentially delaying tax returns.
- Tax Law Changes: Tax benefits related to oil and gas investments can be affected by changes in government policy. For example, deductions like intangible drilling costs (IDCs) and depletion allowances may be reduced or eliminated in future tax law changes.
High Fees and Costs
- Oil and gas LPs often come with substantial upfront costs, including organizational, management, and distribution fees. These costs reduce the net returns to investors.
- Promoters’ Compensation: General partners (GPs) and operators typically take a large percentage of the profits before limited partners (LPs) see returns, sometimes through carried interest or performance-based fees.
Limited Control for Investors
- As a limited partner, investors usually have little or no control over the day-to-day operations of the partnership. Decisions about drilling locations, operational methods, or financing are typically made by the general partner.
- Conflict of Interest: General partners may have interests that don’t always align with those of the limited partners, such as engaging in riskier projects to maximize their own returns.
Regulatory and Environmental Risks
- Oil and gas operations are subject to extensive environmental regulations. Changes in environmental policies, carbon taxes, or regulations governing drilling and fracking could negatively impact profitability.
- Litigation Risks: Environmental incidents such as oil spills or contamination can lead to lawsuits and significant financial liabilities for oil and gas companies and their investors.
Capital Calls
- Some partnerships may require additional capital contributions from investors to fund new projects or cover operational shortfalls, which can place unexpected financial demands on limited partners.
Potential for Fraud
- Oil and gas investments, particularly in private placements, can be susceptible to fraud or misleading information. Investors may be at risk of “wildcatting” scams, where promoters raise money for speculative drilling projects that have little to no chance of success.
If you lost money investing in non-traded REITS or Oil and Gas investments, call the securities and investment fraud attorneys at Israels & Neuman, PLC for a free and confidential case review. We represent investors in FINRA arbitration proceedings in all 50 states.
All of our arbitration cases are taken on a contingent basis, meaning that we do not get paid unless we recover money for you.