The Securities and Exchange Commission has approved the Financial Industry Regulatory Authority’s (“FINRA”) proposed revisions to NASD Rule 2340 regarding per share estimated valuations of unlisted REITs held by customers. FINRA first submitted the proposed rule changes in January 2014. This week the SEC announced its approval of the proposed rule changes. No effective date for implementation of the amended rule has been announced.
A real estate investment trust (“REIT”) is company that owns, and may also manage, income producing real property, such as apartment buildings or shopping centers. To generate funds to purchase its portfolio of real estate, a REIT will pool the capital of many investors. This permits smaller investors who may not be able to individually purchase real estate properties to participate in the real estate market.
There are two types of REITs: those that trade on a national securities exchange and those that do not. The amended rule specifically addresses REITs that do not trade on a national securities exchange, commonly referred to as “non-traded REITs.” Because a non-traded REIT has a very limited secondary market, it is generally illiquid for long periods of time. Early redemption of shares is often very limited, and fees associated with the sale of these products can be high and erode total return.
The lack of an open market for non-traded REITs makes them difficult to value. Typically, brokerage firms have historically listed a per-share price for non-traded REITs as $10, without regard to their true value. The newly approved rule amendment does away with this arbitrary valuation pricing. Amended NASD Rule 2340 requires brokerage firms to develop and reflect on customer account statements a per-share estimated value for an unlisted REIT that is reasonably designed to ensure that it is a reliable value.
Brokerage firms can use either of the two methodologies proposed by FINRA, to wit: the net investment method or the appraised value method. The net investment method requires that firms state the “net investment” amount revealed in the issuer’s most recent periodic report based on the “amount available for investment” percentage contained in the REIT’s offering prospectus. If the prospectus does not reflect the “amount available for investment,” the net investment number should be based on another equivalent disclosure showing the estimated percentage deducted from the total amount of shares registered for sale to the public to cover commissions, fees and other expenses.
The appraised value method will depict the appraised value of the assets and liabilities of the REIT’s portfolio shown in the issuer’s most recent report. The valuations must be performed at least annually in accordance with standard industry practice, and be conducted or verified by a third-party valuation expert.
The newly approved rule also mandates that brokerage firms disclose on customer account statements that non-traded REITs are not listed on a securities exchange, are illiquid, and if sold, the per-share price received may be less than the per-share estimated value reflected on the account statement.