Up until a year and a half ago, Colin Mackenzie, a financial adviser with Cetera Financial Group, says his clients were paying 12% in commissions and other charges for the nontraded REITs he sold them.

Mackenzie, co-owner of Cetera’s Pasadena, Calif., office, says he stopped selling nontraded REITS right around the time FINRA announced a new rule regarding the securities in January 2015. The rule, which took effect two months ago, requires advisers in most cases to report the actual value of those investments – less commissions.

"I don’t want to have any clients ever saying, 'Oh, yeah, by the way, how come this is $88,000 instead of $100,000?'" after getting their first statements following the adoption of the new rule, Mackenzie said in March.

American investors lose about $17 billion a year to conflicted advice in their retirement accounts, according to a study by the White House Council of Economic Advisers. Mackenzie's description of his sales process illustrates succinctly the stakes in the push to reduce conflicts of advice in the industry, some fiduciary advocates say.

Knut Rostad, president of the Institute for the Fiduciary Standard, says that when told of Mackenzie's reluctance to have his clients see the first statement, he thought, “He only made these sales because he could hide what he charged for them." Mackenzie said he routinely informed his clients about all charges and fees associated with their investments.

However, the fact that he stopped recommending the controversial investment products to clients in part because they could see the commission cost in a statement is "a microcosm” of what the U.S. Department of Labor's new fiduciary rule is aimed at changing, says TD Ameritrade's Skip Schweiss, who oversees the custodian's Retirement Plan Services platform.

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Mackenzie also says he stopped selling nontraded REITs because, after the rule was announced, he believed they would become less expensive in the future.


Because they are illiquid, nontraded REITs have not historically reported valuations with regularity. That has helped enable the industry to avoid scrutiny, critics say. However, a new and broad analysis of 89 nontraded REIT found that they generated average annual returns of 4% for investors, compared with 11.3% for their publicly traded counterparts.

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The study includes REITs that either updated their valuations or had liquidity events — sales, public offerings or other inflection points that generated final returns for holders — that occurred between the late 1990s and 2015. An Empirical Analysis of Non-Traded REITs was published this month in the peer-reviewed Journal of Wealth Management (see a draft version here).

"Our findings have important implications for investment advisors who have fiduciary duties to their clients," the study's authors write.

"We estimate that approximately 58% of the wealth losses to nontraded REIT investors are attributable to the upfront fees charged that primarily compensate the distribution agents," the study's three co-authors write. "Our findings have important implications for investment advisers who have fiduciary duties to their clients."


Mackenzie says the nontraded REITs he recommended turned out to be among the investments his clients have been most pleased with, and that he only used them "cautiously and with a great deal of due diligence." He also says he supports the new fiduciary rule, calling this "a good and healthy thing for everyone." The rule aims to reduce Americans' annual losses to conflicted advice in their retirement savings by requiring their advisers to place their clients' financial interests ahead of their own when advising on those accounts.

Although a draft version of the rule banned the use of nontraded REITs in retirement accounts, the final version allows advisers to sell them, provided they are in a client's best interest, or sign a best interest contract exemption.

"I would tell clients, 'Look, this is a really expensive wrapper,'" Mackenzie says

Investors often pay commissions and fees of 15% for nontraded REITs, according to the SEC. The average cost for those 89 REITs in the new study was 13.2%.

Despite these high costs, Americans have invested about $116 billion in nontraded REITs over the past 25 years, the study found. Part of their recent attraction has been a sharp rebound in U.S. real estate values following the Great Recession.


Mackenzie said he used nontraded REITs for their higher returns when bonds were returning about 1.5% or 2%.

"I would tell clients, 'Look, this is a really expensive wrapper. You could put $100,000 here and get 7% a year or we would put it in a corporate bond and you could get 2% a year,'" Mackenzie says.

In the end, all of the REITs he used did well for his clients, he says.

"Every one of the programs that I dealt with had a liquidity event," he said. "The investor earned 6% or 7% the whole time and they also saw some capital appreciation, as well."

One of the three authors of the nontraded REIT study, Craig McCann, a former SEC economist who consults on securities litigation out of Fairfax, Va., questioned how this could be, given that Mackenzie says he was still selling them as late as 2014. The life of an average nontraded REIT until maturity is 6.9 years, his study found. On the low end, some REITs mature in less than two years, it also found, but over such a short period it would take outsized returns to make up for a 12% upfront commission.

Craig McCann, lead author of the nontraded REIT study.
Craig McCann, lead author of the nontraded REIT study.

Mackenzie did not respond when asked for further explanation on this point.

When asked if he tried to hide from clients the high upfront costs, Mackenzie gave an example of one of his clients, a retired CPA. After being offered a number of investment choices, including mutual funds, the client chose to invest in nontraded REITs, "fully understanding the costs and statement pricing," Mackenzie wrote. When asked to make that client available for an interview, Mackenzie declined.

"The long-term impact of the investment, from start to finish, is truly all that is important and each adviser has to carefully evaluate that," he said.

Some fiduciary advocates disagree.

"I don’t want to have any clients ever saying, 'Oh, yeah, by the way, how come this is $88,000 instead of $100,000?'" Mackenzie said.

Mackenzie’s actions are inconsistent with fiduciary duty, which requires the communication of any material fact or a conflict of interest, they say. Mackenzie's CFP designation also binds him to providing fiduciary care to clients when providing planning services.

Mackenzie engaged in "a horrific rationalization," says Rostad of the Institute for the Fiduciary Standard.

The fact that Mackenzie didn't want his client to see an initial statement, less commissions, suggests Mackenzie may have been thinking, “I don't want to disclose this conflict of interest. I don't want to disclose this material fact," McCann says.

Mackenzie declined to respond to these comments.

Cetera Financial provided the following statement through spokesman Joe Kuo: "We require full disclosure of fees to the end clients of advisers while also ensuring that all sales of nontraded REITs undergo a thorough suitability review before being processed. We applaud the goal of driving enhanced transparency for investors that [the new FINRA rule] is designed to help achieve, and we have worked closely with our advisers since last year to assist them with the disclosure modifications the rule provides for."


Historically, brokers have persuaded investors to buy nontraded REITs by telling them that real estate is always a good investment, that REITs produce stable income and their values don't fluctuate as much as bonds or equities, says Hugh Berkson, president of the Public Investors Arbitration Bar Association.

"Those three representations are almost invariably false," says Berkson, who, along with other members of the association, represents investors in disputes with their brokers and firms.

Anthony Chereso, president of the Investment Program Association, a group of many nontraded REIT sponsors, disagrees. With nontraded REITs, "you have a more stable asset because it is not correlated to the overall market," he says.

To the contrary, McCann argues that their boosters can persist in making this claim only because the investments are illiquid and haven’t provided regular valuations. No one should presume an asset is stable simply because an investor doesn't know its value, he says.

"It just means I'm not telling you the truth," McCann says.


In an article about his study, McCann writes, "The wealth transfer from investors to [nontraded REIT] sponsors and their salesforce only survives because of the lack of price discovery."

Stephen Wechsler, president of the National Association of Real Estate Investment Trusts, which counts nearly 50 nontraded REIT companies among its members, did not respond to numerous requests for comment.

Mackenzie says he expects the new FINRA regulation will prompt the commissions on nontraded REITs to drop. In the future, he hopes to be able to sell them in fee-based accounts at no commission.

"I, for one, am very pleased at the pricing pressure the regulation has brought about," he says. "Prudence and helping clients reduce costs are beneficial for everyone."