Scenes from an Independent Brokerage Firm

I consider non-traded REITs or nREITS to be part of the group of investments that are just absolute murderholes for clients – they pay the brokers so much that they cannot possibly work out (and they rarely do wihout all kinds of aggravation and additional costs).

Further, I have yet to hear a single credible explanation as to why a broker would recommend a non-traded REIT over a public REIT other than compensation. The only explanation that makes sense to me is that 7% is a lot more than the 1% commission you get doing an agency trade on a NYSE-traded REIT.

The best excuse I’ve heard is that, because the value of the nREIT doesn’t change in the client’s account, it appears to be less volatile and so is a better holding than a public REIT. The liquidity and transparency being given up by the client in exchange for this illusion of stability is rarely mentioned.

But these products will continue to be the bread and butter of the independent broker-dealer world so long as the sales reps long for product and remain shut out of IPO syndicates from the wirehouses. Non-traded REITs (along with closed-end fund IPOs) are seen as the next best thing. I know guys who make a chunk of their living on these products, supplementing the rest of their income from A-share mutual funds and variable annuities – the Unholy Triumvirate!

I’m sure I’ll get some emails from industry people, it’s not personal guys. But my mind can’t be changed on these things.

A reader with experience in the industry sent this in to me and I found it hilarious. Below, a fictional, transparent conversation between an indie broker and his “client” that would never occur…

***

If Independent brokers were transparent:

Rep:

Before we wrap up our quarterly portfolio review I would like to talk to you about a new investment I think you might be interested in.  You have been looking for more income and this is an investment vehicle that pays a 7% dividend.

Client:

Sounds great, give me the details.

Rep:

With your portfolio size and risk tolerance I would recommend a $100,000 investment.  Given that amount let’s first go over the fees.  If you invest $100,000 I will be paid a commission of $7,000. My firm is going to get $1,500 – $2,000 in revenue share. My wholesaler, the salesman that works for the investment’s sponsor company, will get $1,000. He is a great guy, buys me dinner all of the time and takes me golfing. The sponsor company is going to get around $3,000 to pay for some of the costs they incurred in setting up the investment.  So all in on Day 1 there will be around $87,000 left over to actually invest.  I bet you are getting excited.

Client:

Are you on drugs? Why would I pay 13% in fees on anything?

Rep:

Don’t worry, it won’t feel like you are paying $13,000 in fees. The rules allow my firm to report your investment at $100,000 on your statement. You never really know what its worth but you will think you never lost money. Pretty sweet huh?

Client:

You have to be kidding.

Rep:

No, this is a really good investment. Let me tell you about the income component before you jump to any conclusions. Like I said this investment pays a 7% dividend and the dividend won’t change.

Client:

That sounds high and how do you know it won’t change?

Rep:

You see, the sponsor just picks the 7% dividend number out of thin air. Here’s how it works. You see the vehicle you are going into invest in is new and it’s going to take the firm a while before your net $87,000 is actually invested. Later on, maybe 2-4 years from now they will have the money fully invested and it will generate actual cash flow. So they just pay a quarterly dividend of 7% by giving you your money back.  This is great from a tax perspective because return of capital isn’t taxed as income.

Client:

Are we on hidden camera or something?

Rep:

Ha, you are funny. I bet this next benefit will change your mind.

Client:

I hope so or I should start looking for another financial advisor.

Rep:

This is the best feature. You can’t sell your investment until the sponsor has the opportunity to create liquidity. You might be locked up in this investment for 7-10 years.

Client:

This feels like the Twilight Zone. Your firm allows you to sell this crap?

Rep:

Oh yeah, our firm sells a ton of it. In fact independent broker dealer firms like mine sold over $20 billion of these investments in 2013. Think about that. Reps like me made over $1.4 billion dollars and our firms pocketed $200-$300 million.

Client:

This is crazy, what is this investment?

Rep:

Non-traded REITs. $100,000 sound about right?

Client:

You’re fired!

***

Don’t count on that conversation happening anytime soon in real life. In the meantime, anytime we onboard an account from a client who’s been sold one of these things, it’s a major pain in the ass to get accurate information about them. The exit is even more annoying.

Read more about Murderholes here and here.