Non-Traded BDC & REIT Investments

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Non-Traded Investment Products

Non-Traded Investment Products are classified as Alternative Investment, with the unique characteristics of a being highly non-liquid investment with a significantly higher level of Operating, Distribution, Advisory and Incentive, fees and expenses.  This level of fees and expenses, higher than their “traded” counterparts, brings into question the reasons these securities are recommended by brokerage firms and financial advisors.

The answers provided by brokerage firms which market and distribute these types of securities attempt to justify the lack of liquidity and higher fees and costs.  Brokerage firms and financial advisors may fail to disclose that higher fees and expenses, requires higher returns through investments in riskier assets and the use of greater levels of debt to generate the projected returns.  During period of economic stress, the combination of greater fees, expenses and risks will result in disproportionate losses relative to overall markets.  Did your brokerage firm and financial advisor make this fact completely understood?

Non-Traded Business Development Companies (BDCs)

Business development companies (BDCs) were enacted by a Congressional Act in 1980 to stimulate the U.S. economy to encourage investments in American companies.  BDCs invest primarily in debt issued by small to medium-sized private companies with annual revenues from $25 million to $25 billion. BDCs have been providers of “middle market” debt financing for Private U.S. corporations has exploded since the Credit Crisis in 2008.  Commercial banks no longer play this role since the Dodd-Frank banking reform rules created disincentives for banks to provide capital to this sector of the loan demand marketplace.

Business Development Company investments offer individual investors access to private debt, an asset class that typically was available only to individual with the ability to understand and assume risk, such as high-net-worth and institutional investors.  To evaluate a non-traded BDC, investors have less public information to rely upon to determine historical performance and valuation.  This fact results is greater reliance upon brokerage firms and financial advisors to adequately disclose all relevant facts including the fees, expenses and risks associated with BDCs.

Non-Traded BDCs have annual expenses and fees ratios which are significantly higher when compared to most investments.  Generally speaking, the higher expenses and fees charged to BDC Investors can be summarized into the following categories:

  • Annual Operating Expense Ratios range between 3.00% – 6.00%,
  • Annual Advisory Fees range between 1.50% – 2.00%,
  • Front-End Distribution Costs (Dealer Fees and Commissions) range between 10.00% – 11.50%, and
  • Net Capital Gains from the Sale of Securities payable to the BDC Advisor are 20%.

Non-traded BDCs give investors the ability to purchase shares in a managed portfolio of loans made to private American companies. To evaluate the suitability of a non-traded BDC, consider the following before investing:

  • How does a BDC investment interact with existing portfolio holdings;
  • Investment track record of portfolio manager;
  • Portfolio protections from rising interest rates;
  • Financial reporting transparency, and;
  • BDC Capital Structure.

Investors must examine more closely upon fees, costs and risks disclosed in a prospectus before investing in a non-traded BDC. Some risk considerations include:

  • Limited liquidity and share repurchase/redemption plan subject to suspension and/or modification;
  • Distributions that are not guaranteed in frequency or amount;
  • Effects on valuation from distributions made from loans and return of capital instead of earnings;
  • Limited operating history of portfolio manager, and;
  • Undue reliance upon the financial advisor with conflicts of interest due to high compensation paid.

According to Financial Regulatory Industry Authority (FINRA), non-traded BDCs are not suitable for all investors. Suitability standards generally require an investor to have either a net worth of at least $250,000, or an annual gross income of at least US $70,000. In order to improve investment transparency and suitability standards for non-traded BDCs, FINRA Notice to Members 15-02, requires that brokerage firms disclose more accurate account statement valuations.  A financial advisor who fails to limit the amount invested in BDCs subjects a client to the risks of securities concentration.  Securities concentration risk occurs when a portfolio is over-weighted in a particular asset class or investment product.

Non-Traded Real Estate Investment Trusts (REITs)

Real estate investment trusts (REIT.) that are non-traded are considered non-liquid investments that expose investors to significant liquidity risk. Non-traded REITs have an expected investment life which typically 7-10 years. During the investment lifecycle, non-traded REIT investments are expected to establish positive operating cash flow earnings to enhance the real estate portfolio’s value. The real estate portfolio earnings must recoup the initial start-up costs which can be 15-18% of the capital raised which is paid to financial advisors and promoters of the investment, plus the pay the ongoing management fees before valuations can increase.

Non-traded REITs facilitate limited liquidity through Repurchase Agreements. Repurchase agreements provide for the sale of a limited number of investor units or shares back to the REIT usually a small percentage of the total outstanding shares which can be purchased from investors. Because of liquidity risk, limiting the amount invested in non-traded REITs is the only risk management tool which can be used.  A financial advisor who fails to limit the amount invested in non-traded REITs subjects a client to the risks of securities concentration. Securities concentration risk occurs when a portfolio is over-weighted in a particular asset class or investment product.

Non-traded REIT investments are difficult to value over time because the investment units or shares do not trade on a securities exchange like a publicly-traded REIT. Most non-traded REITs are valued at the initial cost of the investment even though significant start-up costs have been deducted. Even though non-traded REITs report a current yield as a percentage of the Net Asset Value (NAV), in some instances the cash payments are not financed entirely from positive cash flows. In fact, the non-traded REIT payments are financed through use of borrowed funds or as a return of capital. These payments can continue while the NAV is still valued at investment cost leaving investor with inaccurate valuations.

According to Financial Regulatory Industry Authority (FINRA), non-traded REITs are not suitable for all investors. Suitability standards generally require an investor to have either a net worth of at least $250,000, or an annual gross income of at least US $70,000. In order to improve investment transparency and suitability standards for non-traded REITs, FINRA Notice to Members 15-02, requires that brokerage firms disclose more accurate account statement valuations.  It is important to determine what percentage of your investment portfolio should be invested in Non-Traded Real Estate Investment Trusts based on your investment objectives, risk tolerances and investment time horizon.

KlaymanToskes Non-Traded BDC & REIT Investment Current Investigations

KlaymanToskes is currently investigating the handling of investor accounts for securities industry sales practice violations, including concentrated investments in Non-Traded Investments.  Concentrated investments in Non-Traded Investments exposed investors to unnecessary risks, these investments include the following:

What Factors Are Considered to Recover Investment Losses in Non-Traded BDCs and REITs Sustained During the Coronavirus Pandemic?

Investments in Non-Traded Business Development Companies (BDCs) and Real Estate Investment Trusts (REITs)  are highly complex securities with high levels of expense and fees to manage the portfolios along with significant levels of borrowed funds which increase the breakeven point for investment returns.  These factors are not easily understood by investors who lack the sophistication to determine the nature of the risks associated with the strategy.  As a result, investors, many who are retired, must rely upon brokerage firms and financial advisors for advice.  Recommended investments in non-traded BDCs and REITs are unsuitable investment recommendations for investors with income investment objectives and moderate risk tolerances.  In most instances, financial advisors who fail to adequately disclose all relevant costs and risks associated with investments in BDCs and REITs is in violation of sales practice rules and regulations, including misrepresentations and breach of fiduciary duty to their clients.  Additionally, a brokerage firm may have violated securities industry rules for a failure to supervise  due diligence product reviews, sales training and supervision.

KlaymanToskes Can Help Recover Investment Losses

KlaymanToskes has been dedicated to the protection of investor rights for decades, from the Tech Bubble in 2000 to the Mortgage Crisis in 2008. Now, we can help you recover investment losses during the Coronavirus (COVID-19) pandemic.  KlaymanToskes is investigating whether investments in non-traded BDCs and REITS resulted in investment losses suffered during the Coronavirus (COVID-19) pandemic.  The following type of case facts can support a claim for damages:

  • percentage concentration in non-traded BDCs and REITs;
  • liquidity needs of client;
  • investment objective and risk tolerance;
  • tax ramifications; and
  • client sophistication.

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