Fiddich Review Centre
Alternative Investment

State Securities Regulators Propose Drastic Regulations On Non-Traded REITs – Securities

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On July 12, 2022, the North American Securities Administrators
Association, Inc. (“NASAA”), an organization representing
state securities regulators, released a proposal that would have a
significant impact on Real Estate Investment Trusts
(“REITs”) by dramatically expanding state regulation of
non-traded REITs and other investment vehicles. The effect of the
proposal would be to impose requirements that could ultimately
limit investment opportunities for investors in this space, while
heightening potential liability and risk for broker-dealers and
investment advisers who recommend these products.

REITs are an investment vehicle that provides individuals the
opportunity to invest in a real estate portfolio that may contain a
hundred or more residential or commercial real estate properties.
One of the benefits of the REIT structure is that it provides
certain tax advantages for everyday investors while also giving
them an opportunity to diversify their risk beyond traditional
stocks and bonds.

On top of adding additional burdens on the sale of non-traded
REITs, the proposal is notable in that it may serve as a template
for future regulations that could affect certain asset-backed
securities, commodity pool trading products, non-REIT mortgage
programs and non-traded business development companies. These
restrictions could include more limited accredited investor
definitions for the sale of other financial products, and
concentration limits that would apply to all products offered by a
financial firm, not just REITs. Moreover, it would apply additional
and potentially conflicting conduct standards from those already
imposed by federal regulation.


In releasing its proposal, NASAA commented that it had been
working on updating its guidance, originally drafted in 1996 with
minor revisions in 2007, for 15 years for the sale of non-traded
REITs. While the proposal purports to update that guidance, its
revisions instead impose new additions to the guidance.

NASAA initially provided a 30-day comment period to extend to
Aug. 12, 2022, but after pushback from industry participants,
extended that comment period to Sept. 12, 2022. The four primary
additions are the following:

  • Update the conduct standards for brokers selling non-traded
    REITs by supplementing their suitability duty with the federal best
    interest conduct standard and a panoply of other conduct

  • Raise the net income and net worth financial requirements for
    investors to account for inflation since 2007;

  • Create an aggregate concentration limit for investors covering
    their investment in non-traded REITs, the REIT’s affiliates
    (including other funds managed by its sponsor), and non-traded
    direct participation programs; and,

  • Prohibit non-traded REITs from using gross offering proceeds as
    an investment objective or strategy to make distributions.

Both the financial and concentration requirements for investors
stand to vastly impact the sale of non-traded REITs and have broad
implications for the rest of the market for alternative products.
For example, by imposing aggregate concentration limits on
non-listed REIT investments along with investment in the REIT’s
affiliates and in other direct participation programs, the proposal
would stifle the opportunity of retail investors to obtain access
to well-regulated sources of portfolio diversification, inflation
protection and income. Many investors will simply seek these
benefits through less-regulated products.

These new restrictions would not only decrease the pool of
potential investors, but will also increase compliance costs for
REIT issuers and federally regulated broker-dealers and investment
advisers. The concentration limits in turn would disproportionately
impact large firms offering a diverse suite of alternative
investments. While there is no comparable restriction at the
federal level, widespread adoption at the state level for products
with national distribution channels would create a de facto
baseline requirement.

Going forward, as states begin adopting heightened financial
requirements for investors in non-traded REITs, it seems likely
that they begin to question whether the same thresholds should
apply to other alternative asset sales. Moreover, while the federal
law on the accredited investor standard has not been updated since
1982, adoption at the state level could push the SEC to reassess
its rules and potentially adopt further restrictions for all
private investment.


If the proposal is approved without significant revisions, it
may be the first step in greater regulation of alternative
investments. NASAA states their intent is to use the REIT
Guidelines as a template for guidelines on business development
companies, asset-backed securities, commodity pools and other
products. This is a slippery slope for investors that are seeking
access to diversifying products, particularly as traditional equity
investments become less attractive with challenging macroeconomic
conditions, including inflation and volatility. The real question
is whether the proposal is really in the best interests of
investors, or if instead, it is designed to codify regulatory
requirements that expand state regulators’ enforcement

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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