LOST MONEY IN GWG L BONDS? CLICK HERE TO LEARN MORE

Nontraded REIT rules roiled by appraisal issue

If you have lost money in the stock market due to fraud, misrepresentation, negligence, or for other reasons, we can help you. We have successfully recovered over $250 million in FINRA securities arbitrations.*

Need Legal Help? Contact Us. Call +1 (888) 997-9956
Updated on: May 7, 2012

The following story appeared in Investment News on May 6, 2012:

The $84 billion nontraded-REIT industry is deeply divided about valuations as regulators prepare to codify rules on creating an estimated share value for the products.

That division was apparent in comment letters that industry players submitted last month to the Financial Industry Regulatory Authority Inc. Those letters offered arguments for and against Finra’s proposed changes to rules addressing the valuation of private real estate investment trusts and a wide variety of private, illiquid assets dubbed “unlisted direct-participation programs.”

In an indication of the complexity of the issue and the diversity of opinion surrounding it, this was the second time in six months that Finra asked securities firms for responses to its rule proposals about how valuations for such investments should appear on clients’ account statements.

A key sticking point is whether REITs and other private investments should use an independent third party to conduct appraisals.

For example, W.P. Carey & Co. LLC, a leading sponsor of a series of private REITs, with a global portfolio of $12 billion, said that product sponsors “should retain an independent third party to appraise an issuer’s assets at least once each year,” according to the firm’s letter to Finra.

“We believe that the involvement of a third party will enhance the credibility of per-share estimated [net asset values],” W.P. Carey wrote.

“We also think it would ameliorate the perceived and actual conflicts of interest that may exist between the sponsor and the issuer in determining valuations, and provide an independent check” for REITs and other investments that neither undergo an initial public offering or liquidate, the letter said.

FOES SKEWER APPRAISALS

Others disagreed, noting that the wide variety of private-investment products makes mandatory third-party appraisals inappropriate.

One of the private-investment industry’s leading trade groups, the Investment Program Association, for example, wrote: “The [pending Finra] rule should not dictate that the estimate be based on an “appraisal’ of the issuer’s assets and liabilities.”

The letter, signed by IPA chairman Martel Day, said: “Many non-listed REITs and DPPs use very common and highly accepted methodologies to estimate value. Many issuers have engaged third parties to estimate value, while others have engaged third parties merely to analyze the methods and reasonableness of the assumptions used and conclusion arrived at in estimating value.”

The IPA’s letter added that it is developing uniform valuation guidelines.

Finra rules mandate that sponsors of nontraded REITs establish an estimated per-share valuation within 18 months after the REIT stops raising money from investors. The Finra changes, proposed in March, would change the contents of client account statements.

Under the proposal, broker-dealers no longer would be required to provide a per-share estimated value, unless the issuer provided an estimate based upon an appraisal of assets and liabilities in a periodic or current report under the Securities and Exchange Act of 1934.

During the initial offering period, broker-dealers would have the option of using a modified net offering price or designating the securities as “not priced.”

DISCLOSURE

Additionally, Finra is seeking to expand and refine the disclosures regarding valuations on customer account statements.

“We were encouraged by comments on the notice to members, and we’re putting together a filing with the SEC,” said Finra senior vice president Joseph E. Price. “When the commission gets our proposal, a third round of comments will follow.”

The goal of the proposed rule change is to have more transparency about valuations of private REITs and other DPPs so that investors have a better understanding of the process and that a value based on an appraisal is established sooner, Mr. Price said.

The important issue is how “granular” Finra eventually requires the appraisal of the product’s valuation to be, he said.

“It’s not whether there is an appraisal, but what standards” sponsors use in arriving at an estimated value, Mr. Price said, acknowledging that there likely will be some flexibility in the rule because it covers a broad range of programs.

Several major nontraded REITs have seen the value of their shares slashed over the past year, shaking advisers’ and investors’ faith in the sponsors of those products.

“Inland Western Retail Real Estate Trust Inc. last June established an estimated per-share value of $6.95 per share. No independent appraisals were obtained,” the company said in a filing with the SEC, adding that the estimate of the REIT’s real estate holdings “was determined by the company’s management.”

Rechristening itself Retail Properties of America Inc., the company had an IPO last month and, after a reverse stock split, it initially was listed at a price equivalent of about $3.20 a share. Its market capitalization is close to $1.8 billion, but the IPO was for a limited number of the REIT’s investors.

A spokesman for Retail Properties of America, Joel Cunningham, said that the REIT would not comment about its valuation.

“The whole concept of internal evaluations [by management] needs to go away,” said Tony Chereso, chief executive of FactRight LLC, a consultant for alternative-investment firms. “I think everyone is in general agreement about that.”

ENTERPRISE VALUE

Meanwhile, Dividend Capital Total Realty Trust Inc. in March added to its estimated per-share value by including $212 million of “enterprise value” in its valuation methodology. That translated into $1.09 a share, bringing the estimated per-share value to $8.45, according to the REIT’s annual report.

The REIT has more than $3.1 billion in invested assets.

Other major REITs such as KBS Real Estate Investment Trust and Wells REIT II said that they don’t use enterprise value in the valuations.

The president of Dividend Capital Total Realty Trust, Guy Arnold, didn’t respond to phone calls last week seeking comment about the REIT’s use of this metric in its valuation.

Enterprise value stands for “the brand behind the operator,” Mr. Chereso said.

Asked about Dividend Capital Total’s decision to use it in its estimated value, he said: “I was surprised to hear that they included it.”

“Our opinion is that enterprise value should not be included as part of valuations,” Mr. Chereso said.

“We’re not seeing more REITs use enterprise value,” he said. “Most are saying it’s not a component of the underlying assets.”