FINRA issued Regulatory Notice 13-18 to provide guidance to firms on communications with the public concerning unlisted real estate investment programs (“real estate programs”), including unlisted REITs and unlisted direct participation programs that invest in real estate. Communications with the public are covered by FINRA Rule 2210, which generally requires that a firm’s communications be based on principals of fairness, good faith, and balance, and that they not be misleading. The Notice was issued in response to recent findings by FINRA that communications regarding real estate programs: (1) contained inaccurate or misleading statements regarding the potential benefits of investing in real estate programs; (2) emphasized the distributions paid by a real estate program and failed to adequately explain that some of the distribution constitutes return of principal; and (3) have not provided sufficient discussions of the risks associated with investing in the products in order to balance the presentation of benefits.
The Notice provides guidance for compliance with Rule 2210 regarding general disclosure standards, as well as disclosure standards specifically covering (a) distribution rates, (b) stability/volatility claims, (c) redemption features and liquidity events, (d) performance of prior related real estate programs, (e) use of indices and comparisons, (f) pictures of specific properties, and (g) capitalization rates.
Disclosure. Communications must accurately and fairly explain how the products operate, and descriptions of real estate programs must be consistent with the representations in the program’s current prospectus. Additionally, communications that imply that real estate programs are direct investments, or that a real estate program is a REIT before it has qualified under the U.S. tax code as a REIT, would be inconsistent with Rule 2210. Firms that discuss the benefits of an investment are also required to include a discussion of the risks in the same communication and the discussion of risks should not be relegated to a footnote.
Distribution Rates. Firms may not state or imply that a distribution rate is a “yield” or “current yield” or that investment in the program is comparable to a fixed income investment such as a bond or note. Additionally, presentations of distribution rates should clearly and prominently disclose certain information (including, among other things, that distributions are not guaranteed and that distributions include return of principal, if applicable) and should not include an annualized distribution rate until the program has paid distributions that are, on an annualized basis, at a minimum equal to that rate for at least two consecutive full quarterly periods.
Stability/Volatility Claims. A firm may not state or imply in communications that the value of a real estate program is stable or that its volatility is limited without providing a sound basis to evaluate the claim. Also, a communication cannot state that the price at which the program is offered is stable or that its volatility is limited without disclosing that the price stability does not indicate stability in the value of the underlying assets and that the investor may not be able to sell the investment.
Redemption Features and Liquidity Events. If discussing a redemption feature, a communication should clearly and prominently explain the restrictions and limitations of the feature, and should also disclose the fact, if applicable, that the real estate program has not satisfied all investor redemption requests in the past. Additionally, a communication may not comply with Rule 2210 if in discussing potential liquidity events, or their timing, the communication does not disclose that the date of any liquidity event is not guaranteed or may be changed at management’s discretion, if applicable.
Performance of Prior Related Real Estate Programs. If a communication includes prior performance or other historical information about related or affiliated entities, then information about all related or affiliated programs, not just those with the most favorable results, should be included with equal prominence and should be presented in such a manner that it is easy to differentiate it from information about the current program.
Use of Indices and Comparisons. If discussing index performance, a communication must indicate that the performance is not that of a particular real estate program and must also describe the index’s components and any relevant differences with the program’s portfolio investments. FINRA stated, as an example, that it would be misleading to cite the performance of an index of traded REITs to indicate how an unlisted REIT may perform.
Pictures of Specific Properties. Communications for new programs can include photographs or other images of properties owned by investments managed by the program’s sponsors that are similar to the properties the program expects to purchase; however, prominent text explaining that the property is owned by an investment managed by the sponsor and not the program must be included with each depiction. Firms are advised to include depictions of properties that are limited to investments owned by the program once it has acquired a portfolio.
Capitalization Rates. A communication may include a capitalization rate for an individual property within a real estate program, provided the rate is based on current information contained in the prospectus, and includes (1) an explanation of how the rate was calculated, (2) that the rate applies only to the individual property, and (3) that it does not reflect a return or distribution from the real estate program itself. A communication should not include a rate that reflects a blending of multiple individual properties’ capitalization rates.