Exempt real estate-based investments are sold to investors in the private placement market without a prospectus, without the BCSC’s review or approval, and usually, without the advice of a registered dealer.
Real estate-based securities represent an indirect investment in something related to land. They can be sold and traded publicly. Examples include:
- raw land held for resale to a developer in the future (sometimes referred to as “Land Banking”).
- a real estate development project.
- a pool of commercial or residential rental properties known as a Real Estate Investment Trust (REIT).
- an interest in a pool of properties.
- a pool of mortgages, such as a mortgage investment company (MIC).
- a single mortgage (syndicated mortgage).
- a real estate joint venture, which is a combination of parties that pool resources and knowledge to invest and develop real estate projects for profit.
How Real Estate-based Securities Are Sold
You can often purchase real estate investments directly from the company, through a registered investment advisor, or in some cases through an unregistered third party. Purchasing through a registered investment advisor will provide some mitigation of risk because a registered investment advisor will consider whether the investment is suitable for you.
You can buy or sell exchange-traded real estate securities (like a REIT) in the same way you would trade the shares of other public companies.
If you purchase the investment through a private placement, those securities do not trade on the stock exchange and it may be more difficult to sell them than the securities of a public company traded on a stock exchange.
General Risks of Real Estate-based Securities
Like any investment, investments in real estate-based securities are not guaranteed. You may lose all your money.
Some companies offer a Dividend Reinvestment Plan (DRIP), under which you will receive a higher return if you agree to reinvest the income you earn into additional real estate-based securities. However, if you participate in a DRIP, you may not discover if a company has financial problems until you try to cash in your investment (particularly if you do not receive audited annual financial statements from the company).
Risks Associated with Exempt Real Estate-based Securities
It is important to understand that investing through the private placement market (also known as the “exempt” market) may pose additional risks. Private placements are generally sold without a prospectus, and often without the advice of a registered dealer.
Sometimes companies sell these securities under an offering memorandum (OM). The BC Securities Commission (BCSC) does not review OMs before the investment is offered to the public. Companies that issue securities without a prospectus are not required to give investors the same ongoing disclosure (such as financial statements or press releases) as a publicly traded company. Check out our Private Placement Guide to learn more.
You may not have a direct interest in the underlying real estate assets. As a result, you may not be able to take legal steps to seize and sell the assets or foreclose on the borrowers. And because exempt real estate-based securities sold by non-public companies are not publicly traded, the price you pay for your securities may not bear any relationship to the value of the underlying real estate-based assets.
There are risks common to any exempt real estate-based security, such as the ones noted above. This chart shows specific risks of a number of types of exempt real estate investments.
|Raw Land, Development Projects, and Syndicated Mortgages
Costs such as property taxes and management fees may be incurred on an ongoing basis even though the property may not be generating any cash flow.
The developer may not be able to obtain permits for construction or secure construction financing.
Cash you may receive during the development phase usually represents a return of your own money.
If real estate values fall, the REIT may not be able to sell its properties for enough to fully repay you when the REIT is wound up.
Newly formed REITs usually own fewer properties, exposing you to greater risk if a major tenant defaults on its rent or if the property must undergo significant repairs.
While some REITs borrow money from third parties to increase the size of their property portfolios, if the market falls, the REIT may have difficulty meeting its monthly payments on the debt and could even lose the property in foreclosure.
When interest rates are low, MICs may lend money on riskier terms to maintain higher returns (e.g. taking on second or third mortgages or making unsecured loans) – this could expose you to more risk of not earning a return or not recovering your investment.
Some MICs make development or construction loans based on what the MIC thinks the property will be worth on completion. If these assumptions are unrealistic, you may not receive enough to repay your investments.
Different MICs use different valuation techniques to determine a property’s value. If the valuator is not properly qualified, the value of the property, and the underlying security for the loan, may be overstated.
For real estate joint ventures, depending on the transaction’s structure, it may involve a distribution of securities – for example, joint venture limited partnership units. The rights and responsibilities of each party can vary significantly in each negotiated joint venture. An investor needs experience to assess whether they and their joint venture partners have sufficient capital and knowledge to bring a project to fruition. The investment timeline can be long, and it may not be possible for an investor to make a profit or even withdraw their capital for many years.
Finally, exempt real estate-based securities may be more difficult to sell. These securities are not listed on a stock exchange and almost all have resale restrictions. This means you cannot sell your securities once you purchase them (unless a prospectus is filed). It may take you a long time to recover your money.
While many companies offer a redemption feature, there are often significant restrictions on redemption. If you need cash in a hurry, the company may not have sufficient cash to redeem your securities because the money is usually tied up in non-liquid assets, such as mortgages and development projects.
Expected Returns on Real Estate Investments
If the real estate investment is based on mortgages or rental properties, you can expect to receive payments, similar to dividends, as long as the mortgage payments or rents are actually paid.
You can also expect to receive capital gains or capital losses when the property is sold or when you sell your investment – capital gains if the property value has increased, and capital losses if the property value has decreased.
Questions to Ask When Considering Real Estate-based Securities
- Can I get my money back if I need it in an emergency?
- Can I see the redemption history for the past two years?
- How much money does the company owe to people seeking to redeem?
- Has the company diversified its investment portfolio in terms of types of loans, types of properties, and location of properties?
- Can I see the company’s mortgage or property portfolio schedule?
- For development projects or mortgages on those sorts of projects, can I see the valuation reports, including the supporting assumptions?
We’re Here to Help
The BCSC regulates the trading of real estate-based securities. Other real estate investments, like the purchase of a pre-sale apartment from a developer or the purchase of a property, generally fall under other provincial regulatory bodies.
If you want to make a real estate investment, or if you don’t understand what you are invested in, give the BCSC a call. Our inquiries staff can point you in the right direction. You should also call us immediately if you think an investment is a scam.