The Securities and Exchange Commission has opened an investigation of the largest U.S. non-traded REIT, Inland American. According to Inland’s most recent 10Q filing, the SEC is now looking into the number of ongoing fees charged every year to investors holding this non-traded REIT. Over the past two years, we have written extensively about the fee structure of non-traded REITs in general, and the SEC investigation of Inland is consistent with one of our long-standing concerns.
The investigation of Inland by the SEC is captioned “In the Matter of Inland American, Inc.” In its first quarterly report of 2012 issued on May 7, 2012, Inland American discloses the following:
“We have learned that the SEC is conducting a non-public, formal, fact-finding investigation to determine whether there have been violations of certain provisions of the federal securities laws regarding our business manager fees, property management fees, transactions with our affiliates, timing and amount of distributions paid to our investors, determination of property impairments, and any decision regarding whether we might become a self-administered REIT.”
The investigation being conducted by the SEC is non-public, and it may take a significant amount of time before any findings are released to the public.
Our review of Inland American’s initial prospectus filed with the SEC on Aug. 31, 2005, shows some of the upfront fees and commissions charged to investors including a 7.5 percent selling commission, a 2.5 percent marketing contribution, and a 0.5 percent due diligence expense allowance. In effect, in its initial prospectus filed on Aug. 31, 2005, Inland American disclosed:
“We anticipate investing approximately 87 percent of the gross proceeds of this offering, assuming the maximum amount is sold, in real estate assets. The remaining offering proceeds will be used to pay selling commissions, fees, and the costs of this offering and to fund a working capital reserve.”
Moreover, Inland American disclosed in its 2011 annual report filed on March 8, 2012, payments to its business manager —Inland American Business Manager & Advisor, Inc— that include a business management fee of $40 million, as well as an investment advisory fee of approximately $1.6 million.
But apart from the fee issue currently being investigated by the SEC, there are a number of other non-traded REIT concerns that we believe should be shared with investors regarding many non-traded REITs, including Inland. For example, despite its recognition as the largest U.S. non-traded REIT, we note that almost 30 percent of its overall properties are in just four cities: Minneapolis, Dallas, Chicago, and Houston. In fact, on page 38 of its first quarterly report for 2012, Inland American acknowledges that: “Geographic concentration of our portfolio may make us particularly susceptible to adverse economic developments in the real estate markets of those areas or natural disasters in those areas.” Moreover, Inland discloses that approximately 16 percent of its overall properties are leased to only two tenants, AT&T and SunTrust bank.
Additionally, although unclear on the specifics of the properties, Inland American’s 2011 annual report shows that approximately 43 percent of its overall leases expire in the next 1 to 4 years. Finally, Inland American discloses that as of March 31, 2012, approximately $1.5 billion of Inland’s indebtedness bore interest at variable rates.
This is not the first time that an Inland sponsored REIT has been under scrutiny. In 1998, securities attorney Chris Vernon exposed the flaws of non-traded REITs through FINRA arbitration. Vernon successfully recovered losses suffered by retirees as a consequence of their investments in the now-defunct Inland Monthly Income Fund III REIT.
During the course of the binding arbitrations, Vernon asserted that these types of investments should not be pitched to, or sold to retirees because of the high risk involved. In fact, in one of the cases successfully handled by Vernon, the arbitration panel rendered an award not only against the selling brokerage firm but also against the branch manager and the owner of the brokerage firm who sold the Inland products.
The current SEC investigation of Inland American Real Estate Trust, Inc. is not good news for Inland investors or investors in other non-traded REITs. Currently, Inland American investors, as well as investors in numerous other non-traded REITs, can’t redeem their shares unless the investor dies or has a so-called “qualifying disability.” And even in those instances, Inland American currently restricts total redemptions to “$10 million per calendar quarter for the purpose of funding repurchases associated with death and $15 million per calendar quarter for the purpose of funding hardship repurchases.”
The Vernon Litigation Group law firm began raising concerns for investors about non-traded REITs more than three years ago. The firm has filed more than $5 million in claims before the Financial Industry Regulatory involving non-traded REITs on behalf of investors in the past two years. See our article on questions that investors should ask before purchasing a non-traded REIT.