How Some Unlisted REITs Can Look and Act Just Like Ponzi Schemes

One of the worst products, I think, out on the marketplace is a very a high commission product called non-traded REITS. These are not being sold by the wirehouses. I don’t think they’re being sold by Schwab. They’re being sold by small, second and third-tier brokerage firms or independent brokerage firms that have a lot of independent advisors. They’re very high commission. They’re very illiquid. $80 billion of it is out there. So this is huge. They’re selling at a clip of about $10 billion per year.

They’re selling to these folks who retired, thinking they could get 7% on their money. Now, they’re getting 2% on their money, and they can’t really afford their lifestyle. So when somebody comes to them and says, “I got something that doesn’t have the volatility of the market because they’re not traded, they’re illiquid,” which is worse, but they make it sound better, “and we’ll get you 7%,” even though there are some problems in that I don’t have time to get into.

These are bad products, and we’ve been writing about them for approximately two years now. What happens when people get into these, all of a sudden after 18 months, they’re required to report their value according to SEC rules. So for 18 months, if they buy it at $10 a share, the investor’s got a $10 share investment, and it’s stable as far as they’re concerned because there’s no market. So they’re just leaving it at the purchase price.

Then 18 months later, all of a sudden, it comes at seven bucks a share, and they go, “Oh, no.” Then they go, “Oh, by the way, we’re cutting the dividends from 7% to 1% because we don’t have the money.” Then they go, “Well, I want out.” They go, “Uh-oh. Remember there’s a provision in the prospectus that says we can lock up and not allow you to get out, because if there’s a run on the fund, we’ll have to sell all the property. So you’re locked in.”

So now, you think about these folks, baby boomers retired, getting no return on their investment. The investment is going down, and they can’t get out. I think it could end up being a horrible, big picture problem.

I’ll finish on this note. We wrote that we think non-traded REITs remind us of Ponzi schemes and put it up on our blog, and nobody threatened us. I think that speaks volumes. I thought I’d get 20 letters. “I’ll sue you if you say that again.”

But they were having a seminar on the Internet, a webinar, where the REIT issuer was talking to potential advisors who might be selling it. One of the questions from the advisors, it was a Q&A: “How is paying dividends for new equity being raised as opposed to cash flow, not a Ponzi scheme?” If you’re using new money to pay old money, that’s a Ponzi scheme. Jerry McHale knows what a Ponzi scheme is.

Here’s the difference. Here’s what the guy said. I think he got fired right after this, but he said: “The prospectus discloses the dividend may be paid from equity, unlike a Ponzi scheme, where what is done is not that which is promised.”

So, in other words, “We’re running a Ponzi scheme, but we’re telling you about it and therefore it’s not a Ponzi scheme”.

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