Dilemma for Investors in Non-Traded REITs: Sell for Big Loss or Hold

Investors who find themselves trapped in an unproductive and illiquid non-traded REIT investment and stiff REIT losses are now faced with an emerging and confusing trend: lowball tender offers made by third parties who target REITs like KBS REIT I and Behringer Harvard REIT I.

Recently, it has become common for third-parties to send letters to non-traded REIT holders offering to purchase the investors’ REIT investments at very deep discounts of up to 80 or 90 percent.

In deciding whether to sell or hold, investors are torn between the two very bad choices of either liquidating their positions on their REIT holdings for what is likely less than the REITs are now worth or continuing to hold unproductive and illiquid REITs that have not performed at all the way disreputable financial advisors told investors they would at the time of purchase.

If you have invested in any of these products and have received a third-party tender offer, we strongly suggest that you contact an attorney or trusted real estate professional who can assist you with exploring the options you may have before you decide whether to sell or hold.

The Financial Industry Regulatory Association, in a strongly worded investor alert issued today, cautioned investors about the dangers of investing in non-traded REITs and included warnings about risks associated with illiquidity, valuation, and fees. At Vernon Litigation Group, we’ve been warning investors about these very dangers here on reitattorneys.com for more than two years.

An example of the increasingly unfavorable situations REIT investors find themselves in is Behringer Harvard REIT I. This particular REIT commenced public offerings in 2003 at a price of $10 per share. As part of the offering, Behringer Harvard REIT I charged investors the following fees and commissions:

Selling Commissions and Dealer Manager Fees = 9.5 percent
Organization and Offering Expenses = 2.6 percent
Acquisition and Advisory Fees = 3.0 percent
Acquisition Expenses = 0.5 percent
Initial Working Capital Reserve = 1.0 percent

The above fees and commissions, a large portion of which went to the trusted investment advisors who recommended this REIT, demonstrate that only a little over 80 percent of the initial funding was actually available to be invested in real estate. In other words, the investment had been diluted by 16.6 percent before any monies were invested in real estate. And regrettably, the fees and commissions investors are obligated to pay did not stop there. To this day, Behringer Harvard REIT I has the right to collect 4 percent of the gross revenue for property management and leasing fees and  3 percent of the total transactional value each time the REIT acquires or sells a property. Additionally, if this REIT were to ever go public, Behringer advisors would be entitled to up to 10 percent of the entire net asset value of the REIT.

Behringer Harvard REIT I initially began paying investors a 7 percent distribution in 2004. However, according to the 2004 annual report, all or a substantial amount of the dividend amount investors were receiving then was coming from new investors’ money or from loans made to the REIT. Furthermore, the annual report also reveals that the REIT treated more than 91 percent of the distribution as a “return of capital.” This practice of using new investors’ money or borrowed funds to pay prior investors continued all the way until 2008, when the annual report disclosed that “none of the distributions….were distributions from the taxable earnings of real estate operations.” In other words, 100 percent of the distribution came from new investors’ money and/or loans made to the REIT.

Behringer Harvard REIT I closed share offerings to the public on Dec. 31, 2008.  Since new money stopped coming in, distribution amounts plummeted from 7 percent to 3.3 percent, and more recently down to 1 percent.  In addition, just three months after the offering of new shares was closed to the public, redemptions were suspended indefinitely. This means that most investors are currently stuck in this illiquid investment.

FINRA Regulatory Notice 09-09, now requires REITs to re-assess the value of their shares no later than 18 months after the conclusion of an offering. Per FINRA Rules, Behringer Harvard had to re-assess share value last year and notified investors that their shares are now worth $4.55. A disastrous 54.5 percent decrease in value.

In its September 2010 quarterly report Behringer Harvard REIT I disclosed that approximately 271 million shares were issued through public offering. Before the shares were re-priced on May 17, 2010, the REIT was priced at approximately $2.8 billion ($10 per share plus the value of shares issued through distribution reinvestments). The re-pricing of shares to $4.25 reflects a stunning decline in investor value of more than $1.4 billion.

Despite this precipitous drop in share value, most investors cannot redeem their shares. Behringer Harvard REIT I announced in its last quarterly statement dated June 30, 2011, that even exceptional redemptions, such as  redemptions requests due to death or disability,  will be limited to a cap of a little over $1 million per quarter — far less than 1 percent of the total value of the REIT:

“[T]he board determined to suspend until further notice redemptions other than those submitted in respect of a stockholder’s death, disability, or confinement to a long-term care facility (referred to herein as “exceptional redemptions”).  In November 2010, the board set a funding limit of $4.25 million for exceptional redemptions considered in 2011 proportional to each redemption period, or $1,062,500 per period.”

Because of the tremendous losses suffered by Behringer Harvard REIT I and the fact that the REIT is not currently accepting any redemptions, “vulture” third-party firms are now attempting to purchase investor shares at more than 80 percent discounts, or $1.80 per share from the purchase price.

Contact Vernon Litigation Group at (239) 319-4434 or info@vernonlitigation.com if you have information for the Vernon Litigation Group investigation or if an investor in this REIT and you want information about your legal options.

Vernon Litigation Group is a Naples, Florida law firm that represents investors nationwide who are victims of stock fraud and investment losses due to securities fraud and broker misconduct. Vernon Litigation Group’s investment fraud attorneys were among the first to caution investors about the dangers of non-traded REITs. They are currently representing investors nationwide who have collectively suffered millions of dollars in REIT losses in REITs such as Behringer Harvard, Desert Capital, Inland, KBS, Wells, and other REITs.

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