Wall Street’s recent promotion of alternative investments should warrant serious concern among investors. It serves as an unpleasant example of history repeating itself. In the mid-1980s, Wall Street firms became enamored with limited partnerships (a form of alternative investment) that invested in so-called hard assets, paid the firms high commissions and fees, were illiquid and were difficult to value. History shows that most of these limited partnerships later cratered costing investors billions of dollars. Unfortunately, a similar scenario is playing out at present.
Most recently, Merrill Lynch’s alternative investments division staked out territory normally left to smaller independent broker dealers ? nontraded REITs (eerily similar to real estate limited partnerships of yesteryear). The nontraded REIT being marketed by Merrill is called the Jones Lang Lasalle REIT. It pays a maximum 3.5% commission to the firm at the point of sale plus annual trailing commissions. Additional fees are paid to the REIT deal manager and adviser (“In a wirehouse first, Merrill offers a nontraded REIT,” InvestmentNews). It remains to be seen whether this nontraded REIT can overcome that front-end load and deliver an acceptable return to investors.
Merrill is promoting the Jones Lang Lasalle REIT as a safe source of income (“The primary investment objectives are designed to provide attractive current income, [and] preserve and protect invested capital’.”) That is interesting since typically the properties to be purchased by a nontraded REIT are not identified at the time the REIT is offered to investors.
Nontraded REITs have a dismal track record in general. They are, as a group, high-risk, illiquid investments that have proven to be not safe, but rather subject to sharp devaluations. Since the REITs do not trade, there is no market price. Yet valuations were often reported on investors’ monthly statements at the purchase price well after the intrinsic value had deteriorated. Thus, nontraded REITs often create a false illusion of stability and safety.
Income distributions are often paid by returning investors’ own capital to them or with borrowed money rather than earnings. In recent years, many nontraded REITs have cut or suspended distributions.
Many of the smaller broker dealers that sold nontraded REITs and other alternative investments have gone out of business after the the investments crashed and they were hit with large judgments and legal costs they could not pay. These B-Ds typically failed to conduct due diligence before selling the investments to investors, and generally had no intention of disclosing the risks and problems even if they knew about them. Although they were legally obligated to disclose all material risks to would-be purchasers, sellers of these products often view their role as simply sales jobs, and sales are not made by disclosing risks to potential purchasers.
At this point in time, we do not know whether and to what extent Merrill Lynch has done due diligence on the Jones Lang Lasalle REIT or disclosed risks to potential purchasers. We do know that, unlike the smaller firms that folded, Bank of America/Merrill Lynch has the financial wherewithal to pay customer awards if it makes unsuitable investment recommendations that result in large losses.
Investors should be extremely skeptical of claims that nontraded REITs or other alternative investments are safe, stable, or liquid. Investors who are stuck in such investments should contact an attorney with experience in representing investors.
Page Perry, LLC is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.