2014 has the potential to be a watershed year for the Non-Listed REIT industry. If the most likely version of FINRA Regulatory Notice 12-14 (“RN 12-14”) is implemented it will be a game changer; the impact of a single sponsor’s almost complete domination of the market will become more evident; and as Wall Street begins to test the market the results will have a dramatic effect on the future of the industry. I will comment on RN 12-14 here but will reserve comment on the other two market forces that are in play for future issues of NLR Industry Insights. My comments about RN 12-14 are contextual rather than technical.

RN 12-14 has been hanging over the industry since prior to the release of FINRA Regulatory Notice 11-44 in 2011. Throughout the protracted process there has been productive dialogue between the industry, FINRA and the SEC. The Investment Program Association (“IPA”) has worked tirelessly to create a unified industry response. During the process, the IPA has also moved forward with important industry improvements including the development and implementation of a uniform performance metric known as Modified Funds from Operations (MFFO), and a uniform Valuations Guideline. Together these guidelines provide investors in Non-Listed REITs and other direct investments with timely and credible indications of the performance and value of their investments.

It is unfortunate that some regulators and members of the press have been skeptical of MFFO, believing that the metric evolved out of a dubious attempt to make Non-Listed REITs look better than they are. The reality could not be farther from the truth. MFFO came out of an extensive industry wide effort that involved multiple industry associations, program sponsors, independent broker dealers, due diligence analysts, accounting professionals and attorneys to create a uniform performance metric that would provide investment professionals and investors with a valid basis for comparing Non-Listed REITs. And the Valuations Guideline developed and implemented by the IPA is actually more stringent than the current FINRA proposal.

The gap between the regulators and the industry that is making the resolution of RN 12-14 so difficult emanates from the fact that current rules and regulations have been developed to address initial public offerings that involve liquid assets and take place in a matter of days, if not hours. In contrast, Non-Listed REIT IPOs involve non-liquid assets and take years. They do not fit into the current rules and regulations, creating the need for the development of new rules and regulations that are appropriate for the situation. The regulators and the industry must continue to work together in a positive way to develop these new rules and regulations.

In the meantime, some financial advisors have been falsely accused by some regulators and the press of continuing to sell Non-Listed REITS to their clients in an effort to earn high commissions before some version of RN 12-14 is implemented and the window of opportunity closes. Once again the perception could not be farther from the truth. The record setting year for industry capital raise in 2013 was fueled by the amount of money released back into the market through successful liquidity events. A significant portion of that money was reinvested in Non-Listed REITs because investors did well.

It is hard to know the reality of any situation without knowing the underlying motivation. It is hard to know the underlying motivation when looking from the outside in.

Unfortunately, in the financial services industry, it is always easier to believe the underlying motivation for investment program sponsors and financial advisors is self serving and at the expense of their investors and clients. I am compelled to say that in my almost 30 years in this industry I have had the privilege of working with an extremely high percentage of individuals that have considered their success to be contingent upon the success of their investors and clients, not at their expense.

In a similar way it is hard to know the underlying motivation for regulators, especially when looking from the outside in. It is always easier to believe that the underlying motivation is political, reactionary and/or misguided. Again, I have found that the majority of regulators that I have had the opportunity to work with are deeply committed to protecting investors. And those that are fully informed about the industry are committed to working with the industry to develop rules and regulations that are appropriate for everyone involved.

My hope is that the industry and the regulators will continue to work together on FINRA RN 12-14 in a positive way and that those individuals that are fully informed and clearly committed to the well-being of investors will prevail. If so, I believe the game will change in a way that is good for both the industry and investors.

Martel Day
Principal
NLR Advisory Services, LLC