SEC Staff Observations Regarding Disclosures of Non-Traded REITs

On July 16, 2013, the staff of the SEC’s Division of Corporation Finance (the “Staff”) issued CF Disclosure Guidance: Topic No. 6 (“Topic No. 6”) which contains guidance from the Staff regarding non-traded REIT filings.^[1] Most of the guidance in Topic No. 6 regarding distributions, dilution, redemptions, updating disclosure and estimated value per share reflect positions previously articulated by the Staff in comment letters and elsewhere. However, the guidance in Topic No. 6 regarding Industry Guide 5 (“Guide 5”), which is the focus of this Alert, in certain instances represents a significant change from past policies and practices.  

Prior Performance Disclosure

Overall, the Staff’s guidance regarding prior performance disclosure in Topic No. 6 is focused on encouraging sponsors/non-traded REITs to streamline that disclosure. The Staff notes that its views on prior performance disclosure reflects “an appropriate balance between the benefits of providing investors useful prior performance disclosure and the risk that voluminous and complex prior performance disclosure may obscure other material information about the registrant.”

Based on our discussions with the Staff, non-traded REITs that do not present their prior performance disclosure consistent with the guidance in Topic No. 6 in (i) new registration statements filed with the SEC or (ii) post-effective amendments to registration statements filed with the SEC to update prior performance disclosure, should expect comments from the Staff as to why the non-traded REIT believes its presentation is more beneficial to an investor.

Although this new guidance may initially require existing non-traded REIT sponsors to revisit their past practices for preparing prior performance disclosure, over time these streamlined disclosure requirements should save non-traded REITs time and reduce the expense associated with the preparation and distribution of offering documents containing prior performance information.

Prior Performance Tables

Table I: Experience in Raising and Investing Funds

Table I is designed to summarize the experience of the sponsor of the non-traded REIT in raising and investing funds. The Staff states in Topic No. 6 that it would not object if a non-traded REIT limits the Table I disclosure to the sponsor’s three most recent programs with investment objectives similar to those of the non-traded REIT. If the sponsor has fewer than three programs with investment objectives similar to those of the non-traded REIT, the Staff would not object to inclusion of some combination of all programs with similar investment objectives and the sponsor’s most recent additional programs, as long as the total number of programs included is three.

In addition, the Staff notes in Topic No. 6 that it would not object if the information included in Table I is limited to dollar amount offered, dollar amount raised, length of offering in months and number of months taken to invest 90% of amount available for investment. This would allow non-traded REITs to exclude other items, such as offering expenses, reserves, acquisition costs and percent leverage, from Guide 5’s Table I.

Table II: Compensation to Sponsor

Table II was originally designed to show the aggregate amounts that were paid to the sponsor and its affiliates in prior programs. Given the extensive disclosure the Staff requires regarding estimated and actual compensation to be paid to the sponsor in connection with an ongoing offering, the Staff states in Topic No. 6 that it does not believe that extensive disclosure regarding the compensation paid to the sponsor in prior programs is useful enough to investors in the current offering to warrant a separate table. As a result, the Staff will not object if a non-traded REIT omits the information called for in Table II, as long as certain compensation information is provided in Table IV as discussed below.

Table III: Operating Results of Prior Programs

The objective of Table III is to provide an investor with a picture of the operations of the sponsor’s recent prior programs on an annual basis. If the sponsor does not have a “public track record” and does not have at least five prior programs with similar investment objectives, then Guide 5 calls for performance disclosure of all prior programs that have closed in the most recent five years.^[2]  The Staff states in Topic No. 6 that it will not object if the non-traded REIT includes only the most recent additional programs that have closed in the most recent five years, as long as the maximum number of programs presented in the table is five.

The Staff also notes that it will not object if Table III is limited to summary GAAP balance sheet, income statement and cash flow from operations data; distribution data per $1,000 invested, including data on the relationship of cash flow from operations to total distributions paid; and estimated value per share (if disclosed to program investors). The tax related data called for by Table III in Guide 5 can be omitted.

Table IV: Results of Completed Programs

The objective of Table IV is to enable an investor to determine whether the prior programs syndicated by the sponsor achieved their investment objectives. The instructions to Table IV in Guide 5 calls for data for programs that have completed operations in the most recent five years. “Completed operations” was defined in the Guide 5 proposing release as those programs that no longer hold properties. The Staff notes in Topic No. 6 that disclosing only five years of data may result in the omission of prior program data about large, public programs that can provide useful information to potential investors about a sponsor’s track record over a complete real estate cycle. Therefore, the Staff may request Table IV data for completed public programs with similar investment objectives that have completed operations in the most recent 10 years.

If the sponsor does not have a “public track record” and does not have at least five prior programs with similar investment objectives, then Guide 5 calls for performance disclosure of all prior programs completed in the last five years. However, for sponsors that do not have a “public track record” and do not have at least five prior programs with similar investment objectives completed in the last five years, the Staff states in Topic No. 6 that it will not object if the non-traded REIT includes only the most recent additional programs completed in the last five years, as long as the total number of programs covered by the table is five.

The Staff also notes in Topic No. 6 that it will not object if the information in Table IV is limited to the annualized return on investment, date closed, duration in months, aggregate dollar amount raised, and median annual leverage. It should be noted that annualized return on investment is a new requirement that is not included in Guide 5’s Table IV. The Staff did not dictate how non-traded REITs should calculate the annualized return on investment, but the Staff does note that it would not object if return on investment is calculated as (i) the difference between the aggregate amounts distributed to investors and invested by investors, divided by (ii) the aggregate amount invested by investors multiplied by the number of years from the non-traded REIT’s initial receipt of offering proceeds from a third-party investor through the liquidity event.

Data with respect to the  amount raised from investors, any underwriting fees and commissions disclosed to investors and paid from the amount raised may be excluded from Table IV. Also, the Staff states in Topic No. 6 that the previously required tax-related disclosure and the source of distribution data in Table IV may be omitted.

Additionally, as noted above, the Staff states in Topic No. 6 that it will not object if the non-traded REIT omits Table II so long as it includes compensation data in Table IV.

Table V: Sales or Disposals of Properties

Table V is designed to disclose to an investor the profit or loss upon the sale of properties, and the positive or negative operating cash flows during the holding period. The Staff did not provide any changes in Topic No. 6 to past practices regarding Table V.

Table VI: Acquisition of Properties by Programs

Table VI calls for detailed information about individual property acquisitions, including mortgage financing, cash down payments and capital expenditures. The Staff notes in Topic No. 6 that it does not believe that detailed information about the financing and expenses associated with individual property acquisitions made by the sponsor’s prior programs is likely to be material to an investment decision in the non-traded REIT. As a result, the Staff generally will not object if a non-traded REIT omits Table VI.

Summary of Acquisitions

Given the acquisition disclosure called for by Item 8.A(1) of Guide 5 and the investment data in Table I, the Staff notes in Topic No. 6 that it will not object if a non-traded REIT omits the summary of acquisitions called for by Item 8.A(4) of Guide 5.

Undertakings

Non-traded REITs conducting registered continuous offerings must regularly update their prospectuses to comply with the Securities Act of 1933, as amended (the “Securities Act”). The undertakings in Item 20 of Guide 5 facilitate this process and non-traded REITs typically include these undertakings in Securities Act registration statements.

Item 20.A

The Staff will not object if a non-traded REIT omits the Item 20.A undertaking of Guide 5 because the substance of that undertaking is addressed in Rule 401 of the Securities Act, and Item 512(a) of Regulation S-K.

Item 20.D

Item 20.D provides the undertakings that non-traded REITs should include in blind pool offerings. These undertakings describe sticker supplements, post-effective amendments and Form 8-K filings that the non-traded REIT should make to reflect the acquisition of properties with the offering proceeds.

The Staff notes that it will not object if a non-traded REIT slightly modifies the first paragraph of the Item 20.D undertaking as follows (the new language added by the Staff is denoted by an underline and language that has been deleted is denoted by a strikethrough):

“The registrant undertakes to file a sticker supplement pursuant to Rule 424(c) under the Act during the distribution period describing each significant property not identified in the prospectus at such time as there arises a reasonable probability that such property will be acquired and to consolidate all such stickers into a post-effective amendment filed at least once every three months, with the information contained in such amendment provided simultaneously to the existing limited partners or shareholders. Each sticker supplement should disclose all compensation and fees received by the General Sponsor(s) and its affiliates in connection with any such acquisition. The post-effective amendment shall include or incorporate by reference audited financial statements meeting the requirements of Rule 3-14 of Regulation S-X only for that have been filed or should have been filed on Form 8-K for all significant properties acquired during the distribution period.”

The second paragraph of the Item 20.D undertaking relates to commitments to purchase properties that are made after the end of the distribution period. Under this paragraph, non-traded REITs undertake to file a Form 8-K containing the financial information required by Rule 3-14 of Regulation S-X to reflect each purchase commitment involving the use of 10% or more of net offering proceeds.

The significance standard imposed by Item 20.D for acquisitions in the post-distribution period is different from the Staff’s interpretation of significance during the distribution period. In addition, while Item 20.D directs a non-traded REIT to undertake to file a Form 8-K containing the financial information required by Rule 3-14 of Regulation S-X at the time of any significant purchase commitment made during the post-distribution period, during the distribution period a Form 8-K with Rule 3-14 financial information is not required until the time of acquisition.

Given the Staff’s belief that the Item 20.D post-distribution period significance measure and Form 8-K filing trigger do not benefit investors and result in unnecessary regulatory complexity, the Staff states in Topic No. 6 that it will not object if a non-traded REIT modifies the second paragraph of the Item 20.D undertaking as follows (the new language added by the Staff is denoted by an underline and language that has been deleted is denoted by a strikethrough):

“The registrant also undertakes to file, after the end of the distribution period, a current report on Form 8-K containing the financial statements and any additional information required by Rule 3-14 of Regulation S-X, to reflectfor each commitment (i.e., the signing of a significant property acquired and to provide binding purchase agreement) made after the end of the distribution period involving the use of 10% or more (on a cumulative basis) of the net proceeds of the offering and to provide the information contained in such report to the Limited Partners or shareholders at least once each quarter after the distribution period of the offering has ended.”

Supplemental Information

Guide 5 calls for non-traded REITs to undertake to provide investors with certain additional information. For example, Item 8.A directs non-traded REITs to include an undertaking to provide, upon request, the most recent Form 10-K for a sponsor’s public prior program and the Table VI acquisition data. Similarly, Item 20 includes undertakings to furnish to limited partners and shareholders annual statements of transactions with and compensation paid to the sponsor, financial statements required by Form 10-K for the first year of operation, and information about probable acquisitions. In lieu of physically providing this information, the Staff states in Topic No. 6 that it will not object if a non-traded REIT satisfies its undertakings by making the information available on its publicly accessible Internet website, provided the prospectus discloses the website address and investors can obtain the information without a subscription fee.

Given the extent of the changes outlined in Topic No. 6, especially to the prior performance disclosure, we suggest that existing non-traded REITs and their sponsors begin reviewing the changes with outside counsel to assess the impact on their disclosure.