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Exposed: Wall Street's Outrageous New Scam -- By Louis Navellier

Photo: Louis NavellierDear Reader,

I’ve spent my entire career trying to help investors safely grow their money. I believe in putting my clients and their needs first.

That’s why it burns me up every time I see others on Wall Street take advantage of investors in order to line their own pockets.

I know I can’t protect you from every bad investment, shady financial advisor or get rich quick scheme out there… but there’s one product being hawked right now that I need to sound the alarm about today.

After Wall Street’s reckless mortgage-related products helped crash the housing market and almost destroy the economy in 2008, I figured it would be quite some time before I saw such a blatant disregard for investors again.

It turns out, I was wrong.

Wall Street is already playing fast and loose with another shady product and the losses piling up for investors are staggering.

This product is sold as a safe, income-producing investment. They tell investors it can practically guarantee you 8% to 10% a year in income. And they say this is a private investment, often reserved for the wealthy and the connected.

If I offered you an investment that could “practically guarantee” you 10% a year, would you take it?

If you said ‘yes’, then you’re like most other investors out there starving for income these days.

Checking accounts pay next to nothing… money market accounts only a little more… the S&P 500 dividend yield is a paltry 1.9%…even the 10-year Treasury is hovering around just 2%.

That’s why investors have recently been charmed by the promise of yields of 8%, 10% and even more in a toxic version of a very popular investment—REITs.

But the promises of a steady stream of cash for investors were too good to be true.

The reality is that rather than delivering investors income of 10% per year, they’ve actually delivered an average LOSS of 10% per year.

Shady financial advisors have pushed this product hard over the past five years, convincing unsuspecting investors to put nearly $50 billion into this toxic asset.

That’s why I set my team off on a detailed investigation to expose one of Wall Street’s biggest schemes.

In the next few minutes I’m going to show you the dark side of this new type of REIT.

And you’ll hear first-hand from industry insiders with intimate knowledge of these products who were willing to talk to us anonymously to help expose them for the dangerous investment they are.

A Simple Way to Invest in Real Estate

First off, let’s make sure we’re all starting on the same page…

REIT stands for Real Estate Investment Trust.

According to Investopedia, “A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges like a stock. REITs provide investors with an extremely liquid stake in real estate. They receive special tax considerations and typically offer high dividend yields.”

Sounds pretty good, right?

It can be, but the devil is in the details.

You see, there are two types of REITs — publicly-traded REITs and privately-traded REITs.

Publicly traded REITs have been around for more than 50 years, and some of the best ones have even made it into my own dividend investment portfolio.

They’ve become such a common piece of investor portfolios that they account for a significant part of the new officially-recognized Real Estate Sector.

A REIT is similar to a mutual fund or an ETF. REITs allow investors both large and small to acquire ownership in real estate assets and a share of the profits from the operation of commercial real estate properties. These might be apartments, hospitals, malls, warehouses, hotels, and offices — REITs allow you the chance to own a piece of them all.

There are a few rules to operate as a REIT:

  • There need to be a minimum of 100 shareholders
  • Five of these shareholders together cannot represent more than 50% total ownership
  • A minimum of 75% of the REIT’s assets have to be invested in real estate, cash, or treasuries
  • 75% of gross income must come from real estate
  • At least 90% of net income must be paid in the form of a dividend

That last requirement is what makes REITs appealing to investors seeking income.

Thanks to federal law, when a real estate company establishes itself as a REIT, it can legally avoid almost all federal tax liability. It just simply deducts the dividend payouts along with operating costs and other expenses, leaving it with virtually no net income and no taxes due.

That makes it incredibly appealing for REITs to pay out huge dividends.

The beauty of publicly-traded REITs is they offer the everyday investor a liquid way to invest in real estate. Dividend yields can be in the double-digit percentage annually, which is especially attractive in a low rate environment such as we’ve been stuck in for the past decade.

But once again, Wall Street has taken a really great, well-established investment vehicle and twisted it into something dangerous.

Private REITS Have A Crucial Difference
That Is Causing Huge Losses

Private REITs are also REITs. But the big difference is they are not listed on any stock exchange and are not available to be freely traded.

The attraction — and main selling point for financial advisors — is that by getting access to these “private” investments, you can collect a higher yield than those offered to “regular” investors in public REITs.

On the surface, a private REIT has all the benefits an income-starved investor could hope for…

Tax efficient REIT structure that forces them to pay me first… check.

Potential for stock-like gains, just like with publicly-traded REITS… check.

A higher yield thanks to the exclusivity of the “private” investments… check.

There’s only one problem…

Private REITs Keep Everything Private

But things can go spectacularly wrong when you invest in Private REITs.

You see, unlike a publicly-traded REIT that is required to disclose all their assets and what they’re worth, private REITs tend to keep everything a closely-guarded secret.

They’ll let you inside that velvet rope long enough to convince you to invest, but they won’t let you poke around long enough to see what’s really going on.

And some private REITs have handed investors HUGE losses.

Let’s begin with a simple illustration. An investor puts $100,000 into a private REIT paying an 8% yield, as promised by their financial advisor.

Each year they pocket $8,000 from the dividend payments, just as promised. This is a great return in a low yield market.

Oh, by the way, in exchange for being given the privilege to invest with this private group, you do need to pay your broker a commission. In many cases, commissions can often be as high as 8% annual on principal, and often significantly more.

So now you are probably thinking that after commissions, the investor is at breakeven from a return perspective… but that’s not the case at all.

Because in the world of private REITs, there is no requirement for any appraisal value on the principal on the underlying investments. It’s like agreeing to buy a house for $500,000 without having an appraisal done to see if it’s actually worth that much.

This is where Private REITs can get ugly.

The investor thinks they’re making out great, collecting 8% a year in dividend payments on the investment.

But because they never received an update on the value of the private investments held in the REIT, they were often sitting on assets that were losing value every year. In some cases, investors lost 30% in 3 years and 70% in 7 years.

You read that right… an average loss of 10% per year from the principal.Add in the exorbitant commissions and it wasn’t uncommon for investors to lose as much as 20% per year… all while thinking they were making a safe, steady 8% to 10% per year.

But they never knew about these losses until it was too late.

The saddest part of all is that the investors who got hurt the most were the very investors who sought stable income on a conservative investment: retirees.

The other danger I have to mention is that private REITs are normally non-liquid with restrictions on early redemption. Often it was five years or more before investors could request to pull their investment back out, and by then, there was little if any principal left.

You Won’t Believe What Industry Insiders
Say About Private REITs

We questioned several industry professionals about their experiences with Private REITs. What they say is downright disturbing. They spoke to us on the condition that we protect their identities, but I assure you these are very real people.

Ken spent nearly 2 decades working for major investment banks. His task, among others, was trading large blocks of CMBS (Commercial Mortgage Backed Securities) RMBS (Residential Mortgage Backed Securities), CMO’s (Collateralized Mortgage Obligations), CDO’s (Collateralized Debt Obligations), and several other products linked heavily to the Real Estate market.

When it comes to knowing the ins and outs of Wall Street and the products they design, he’s seen it all.

And his comments on Private REITs were not exactly glowing:

Non-traded REITS, in my experience, exhibit qualities of a Ponzi scheme. There is a huge sales load of anywhere from 8-14%. There is an uncertainty of how these assets will achieve consistent yields when not starting out at 100% after the load. By this I mean, if you invest say $100,000, then before you even get going, the sales load wipes out 8-14%!

Now the investment has to service the payout, in which the ratio goes higher and higher relative to shrinking principal. Therefore, in order to service the investment, it either has to be heavily leveraged or it has Ponzi-like behavior. I have heard of instances in which “borrowed capital” was used to service payments. If “borrowed capital” is borrowed from new investors to pay difficult to service yield on older investors — what does that sound like to you? I don’t throw around a word like “Ponzi” lightly.

Given that the investors often start out at 85 cents on the dollar and are promised healthy dividend yields while bleeding concealed fees, it is unsustainable. For the last 5 years we have had a historically low rate environment. Who wouldn’t be enticed to earn 10% when treasuries yield 1-2%? And liquidity? HA! Liquidity events were often 7 years out. I used to structure trades where I offered liquidity for the REIT to pay investors for their liquidity event because they couldn’t service the investment. In exchange, I ended up owning the actual real estate for deep discounts…

After hearing those bone-chilling remarks, we also discussed one of the most questionable Private REITs sold to investors — Apple REIT (not to be confused with Apple Inc.).

According to Law360, “Apple REIT Nine Inc. and investment firm David Lerner Associates Inc. were hit Wednesday with a putative class action in New York state court by Apple REIT shareholders who claim they were misled into buying artificially inflated shares in a $6 billion Ponzi scheme.”

The Lead Plaintiff claimed that the underwriter misrepresented the value of the underlying investment. Similar stories of cataclysmic losses were seen at Beranger Harvard where one blind-sided investor lost 96% of their principal!

The good news about this dark world is that regulators and law makers are trying to shed light on it. In fact, the SEC is now forcing firms to obtain private appraisals to determine the value of the non-traded REIT. This forces them to tell investors the actual value of their underlying principal.

Now let’s hear from one more insider…

The Lawyer

Dave is a securities attorney on the west coast of Florida in an affluent city where many retirees seeking a big, steady income were lured into Private REITs. Here’s what Dave had to say from his experience:

I have been a securities attorney for over 10 years. I have represented over 700 suits mostly involving poor investment recommendations. Well over 50 of these cases involved non-traded REITs. Most of those cases had an overconcentration of assets allocated to them; 25% or more! In every single case, clients were unaware of how large the commissions were.

The people I represented were all told that the commissions were “built-in” and there were no out of pocket fees. They were told, “You can get 10% in this low rate environment, and we don’t go out too far on risk or duration.” In short, they were talked into something they did not understand. One of the biggest points of confusion was when it came to liquidity, and when the event finally came around, there was nothing left. So one trick that was pulled a lot was when the client would ask their broker about liquidity, and the advisor would keep pushing it off saying “not yet, I’ll see when we can, but in the meantime you’re getting 10% so hang in there!” The liquidity event can kept getting kicked down the road and never really came.

The worst part for me was seeing the poor investor who elected to reinvest their dividends and buy more shares. They never earned anything from their investment! All of their money went to fees! Think of that! Imagine if almost 100% of your investment was eaten up by humongous sales commissions paid to the person who put you into an investment like this. The dividend re-investor kept buying more shares of something they thought was secured by actual properties. Then the dividend got cut. Then it got halted. Then the dividend outlook was “we’ll see

The Moral of the Story: Beware Dividends
Not Backed by Solid Fundamentals

By now, I hope I’ve convinced you that Private REITs are simply not worth it.

A 10% yield doesn’t do you any good if you’re paying 8%-14% in fees AND losing money on the underlying investment.

The fact is, not all income investments are equal and fundamentals still matter. Ignore them, and your search for extra income could end up costing a lot more than you expect.

And Private REITs aren’t the only dangerous investments income seekers are turning to.

Tomorrow I’ll be sending you a report on another group of high yielding investments luring in investors with big yields that you need to avoid at all costs.

And then on Monday morning, I’m going to show you where you can safely get the income you are looking for AND market-beating growth, too.

Watch for it Monday morning at 11:00 am.


Louis Navellier
Navellier Growth

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