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Be Wary of Sales Pitch Used by Financial Advisors Selling Non-Traded REITs

Many sellers of non-traded REITs tout their list of top high profile tenants, using them as a vehicle to convey to investors and potential investors a sense of investment security. In reality, however, the existence of high profile tenants in a large real estate holdings pool is by no means an assurance against REIT losses.

The above is true with Cole Credit Property Trust III. According to its 2009 and 2010 annual statements, Cole Credit Property Trust III reported an occupancy rate of 99 percent of its properties. Cole’s website shows pictures of current tenants such as Walmart, Home Depot, Walgreens, and Staples, to name a few. On Cole’s own YouTube channel, the head of Real Estate Investments for Cole Capital Acquisitions accentuates high profile tenants as a crucial strategy “to be able to pay dividends on a monthly basis.”  It is therefore understandable that investors might feel that investing in this non-traded REIT is a safe undertaking.

But even with almost 100 percent of its properties fully occupied and leased, Cole Credit Property Trust III managed to report losses of almost $8 million in 2009.  Despite the reported losses, the Chairman and President of Cole Properties Christopher H. Cole decided that it was proper to announce in a letter to stockholders dated April 6, 2010, that the REIT was increasing its distribution rates from 6.5 percent to 7 percent.  From our perspective, the increased rate of distribution and the source of the distributions raise concerns, given the losses reported by this non-traded REIT.

We continue to have concerns about Cole Property Trust III in 2010 and 2011, year to date. To this day, public records reflect that Cole is far from covering its dividends with funds coming from operations. In its third-quarter report for 2011, Cole Credit Property Trust III reported total revenues for $81,414,000 and operating expenses for $52,079,000; leaving a net income of $10,491,000. Nevertheless, Cole paid dividends to its shareholders of $46,755,845 or $36 million in excess of its net income. In other words, Cole Credit Property Trust III continues to pay most of its dividends with loans or proceeds from new investor’s money.

Cole Credit Property Trust III’s business practices could be accentuated when its offering concludes on Sept. 22, 2012.  As a reference for investors, below is the 2010 year-end status of the other two Cole REITs now closed to new investors, according to annual reports filed by Cole with the SEC.

  • Cole Credit Property Trust  -approximately 100 percent of all properties leased-
  • Initial offering 2004. Now closed to investors.
  • Re-priced shares from $10 to $7.65 (34 percent decline in price assigned by the REIT)
  • Declared a net income loss of $2,626,000.
  • Distributions reduced from 7 percent to 5.5 percent. More than 67 percent of all distributions were treated by this REIT as a return of the investors’ capital.
  • Redemptions suspended indefinitely.  As a practical matter, investors cannot redeem their shares unless they sell them in the secondary market at a deep discount.
  • Leverage ratio of the REIT’s portfolio: 60 percent, i.e. the ratio of debt to total gross real estate assets.
  • Cole Credit Property Trust II  -approximately 94 percent of all properties leased-
  • Initial Offering 2005. Now closed to investors.
  • Re-priced shares from $10 to $8.05 (20 percent decline in price assigned by the REIT).
  • Distributions suspended and then reinstated in Sept. 2010 at 6.25 percent More than 64 percent of all distributions were treated by the REIT as a return of the investors’ capital.
  • 2010 distributions included the return of capital from unconsolidated joint ventures of $1.6 million, proceeds from the Offerings of $3.4 million, and borrowings of $18.7 million.
  • Redemptions were suspended indefinitely and then reinstated with several amendments. Now, the REIT will not redeem in excess of 3 percent of the weighted average number of shares outstanding during the prior calendar year and the cash available for redemption is limited to the proceeds from the sale of shares pursuant to their share re-investment program (DRP) during such calendar year.
  • Leverage ratio of the REIT’s portfolio: 50 percent (i.e. the ratio of debt to total gross real estate assets).

Based on the performance of the two Cole REITs described above, investors may want to have an objective and competent investment professional closely evaluate Cole Credit Property Trust III, especially because 1) it is run and managed by virtually the same group or individuals, and 2) it is similarly promoted as seeking and having high-profile and reliable tenants.

Vernon Litigation Group continues to urge investors to seek second opinions from investment professionals before investing in these very complex non-traded REIT products.  Just three weeks ago, The Financial Industry Regulatory Association (FINRA), issued an investor alert cautioning investors on the dangers of non-traded REITs, including illiquidity risks, valuation methods, and excessive fees.