B-Ds taking a break from nontraded REITs

Even as sales of nontraded real estate investment trusts skyrocketed in the first half of the year, regulatory concerns have arisen, causing broker-dealers to take a harder look at what they've been selling. Last week, three independent broker-dealers indicated that they are suspending sales or terminating relationships with two of the most popular companies in the industry. The reasons varied, from “due diligence” concerns with a nontraded REIT at one broker-dealer to selling too much of a nontraded REIT at another. A third broker-dealer said a non-traded-REIT company hadn't met its standards for corporate governance. Last Monday, National Planning Corp. said that it would suspend sales of American Realty Capital Trust V Inc., known as ARC V in the industry, because of due-diligence concerns, including “style drift, deviations from the prospectus and growing pains” exhibited by a related REIT. Earlier, another broker-dealer, Securities America Inc., said that it would suspend sales of ARC V, not because of due-diligence concerns but because it had recently implemented a policy limiting the amount of any one alternative investment it sold. It had recently met that threshold with ARC V.

Violated standards

Meanwhile, Advisor Group last week said that it had cut its selling agreement with Cole Holdings Corp., the noted nontraded-REIT sponsor, citing Cole's management decision to pay itself and founder Chris Cole a $127 million fee this year. Advisor Group said the transaction and the fact that it wasn't put to a shareholder vote “violated its standards of appropriate corporate governance.” Nontraded-REIT sales reached $7.8 billion in the first half, an increase of 68.2% from last year, according to investment bank Robert A. Stanger & Co. Inc. The booming market in nontraded REITs has been concentrated in a handful of companies. For example, American Realty Capital was responsible for 39.2% of all nontraded-REIT sales in the first half, according to Stanger. Broker-dealers' concerns regarding concentration, or selling too much of one sponsor's products, stems from a history of blow-ups of other alternative-investment products in recent years, said Stanger managing director Keith Allaire. “A broker-dealer executive is probably thinking he doesn't want to have — whatever the number is, $500 million or $700 million — of our clients' investments incumbent on one investment,” Mr. Allaire said. Massive alternative-investment-product failures that turned out to be Ponzi schemes, namely notes issued by Medical Capital Holdings Inc. and preferred shares of Provident Royalties LLC, are a factor pushing broker-dealers to become more cautious about sales, Mr. Allaire said. “Broker-dealers sold a huge amount [of MedCap and Provident] and took it in the teeth,” he said. Amid increasing pressure from regulators, broker-dealers this year have been making changes to how they sell alternative investments. This year, Berthel & Fisher & Co. Financial Services Inc., Cetera Financial Group Inc. and VSR Financial Services Inc. revised policies or added guidelines and procedures for the sale of certain alternatives, including nontraded REITs. The changes by broker-dealers in sales relationships with product sponsors came over a three-day period in the middle of the month.

Maintaining thresholds

Securities America told its registered representatives and financial advisers in an e-mail July 12 that it will no longer offer ARC V, which was the top seller last month, averaging $10.8 million in daily sales, according to Stanger. Brokers sold $406.6 million of ARC V between its launch in April through June 30. “An important risk management tactic implemented by Securities America and other firms is maintaining certain thresholds limiting total firm investment in any one alternative product or sponsor,” according to the e-mail from senior vice president Paul Lofties. The move by Securities America to stop sales of ARC V actually showed prudence on the part of the broker-dealer, said Nicholas Schorsch, chief executive of American Realty Capital. “Securities America has never had [a REIT sponsor] sell so much, so fast,” he said. Last Monday, National Planning Corp., an affiliate of insurance company Jackson National Corp., said that it was suspending sales of ARC V because of concerns related to another American Realty Capital REIT, American Realty Capital Trust IV Inc. That REIT in June said that it was purchasing 986 properties from an affiliate of General Electric Capital Corp. for $1.45 billion. The vast majority of those properties are fast-food and casual-dining restaurants. “Based upon the GE transaction, the portfolio for [ARC IV] does not match the [REIT's] stated strategy in terms of the average credit rating of the portfolio,” according to an e-mail sent to all NPC reps from the firm's products group. That strategy called for a target of 50% of its portfolio in investment-grade and creditworthy properties. Although it was suspending sales of ARC V, NPC wrote in the same e-mail that it was adding to its selling list another American Realty Capital REIT, the Phillips Edison-ARC Shopping Center REIT II Inc. “We have a great relationship with NPC,” Mr. Schorsch said.

DUE DILIGENCE CONCERNS

Other broker-dealers haven't expressed such due diligence concerns stemming from the ARC IV purchase of the GE Capital portfolio, Mr. Schorsch said. Advisor Group told its advisers the following day that it was terminating its relationship with another popular REIT company, Cole Holdings, because, “among other reasons, of a related party transaction between Cole Holdings and Cole Credit Property Trust III,” according to an unsigned internal e-mail from Advisor Group, which is owned by American International Group Inc. “The REIT recently acquired Cole Holdings, its sponsor/adviser, and this "internalization transaction' was not submitted to a vote of the REIT shareholders,” according to the e-mail. Cole will work to restore its relationship with Advisor Group, said Jeff Holland, president and chief operating officer of Cole Real Estate Investments Inc. “We respect their right to make such a decision and recognize that changes in selling relationships are something that every sponsor faces in this industry,” he said. “We obviously hope that, in the future, Advisor Group will reconsider, and we will work diligently to restore our long-standing partnership.”