Real estate funds not sure thing for San Diego retirees

Beware nontraded real estate investment trusts. That advice was issued early this month by the Financial Industry Regulatory Authority, the nongovernmental regulator of securities firms.

Real estate investment trusts (REITs) pool money from many investors, put the money in real estate, and distribute 90 percent of taxable income to shareholders. Some trusts trade on the stock exchanges, so their prices can be volatile. Nontraded trusts have a constant price and generally pay fat distributions (essentially, dividends). They’re comforting to own in years like 2008, when stocks crashed.

But the regulatory authority warns that front-end fees are high (a whopping 10 to 15 percent). The distributions can come from borrowed funds and include some of the investor’s own money. Because they are not traded, they are illiquid for a long period (say, 10 to 15 years); ultimately, most of them either become publicly traded or liquidate. “Early redemption is often restrictive and may be expensive,” says the regulatory authority.

Jim Ketchum, retired news editor of the Union-Tribune, was sold shares of Wells II, a nontraded trust that invests mainly in office buildings. But Ketchum’s wife has advanced Alzheimer’s; he wants his money. Alas, under new, tighter Wells rules, he doesn’t qualify for emergency status; if he wants to get out now, he can receive only $18,000 of his $30,000 investment.

He bought Wells from Michael Lucia, who was then working for a firm run by his brother, radio-TV personality Ray Lucia. Ray has sold his business to his son Ray Jr. and now concentrates on a nationwide radio show, TV appearances, writing books, and consulting. Michael has his own smaller firm, Michael Lucia & Associates. The firm owned by Ray Jr. is RJL Wealth Management.

For the last four years, Michael has not sold the nontraded trusts. “It’s a terrible time to have to sell real estate. The REITs are cutting back on the redemption process,” he says, expressing sympathy for Ketchum. However, all customers received material warning of the risks, says Michael.

On the air and in his books, brother Ray Lucia strongly defends high-quality, nontraded real estate investment trusts, although he admits some are stinkers. He doesn’t think the extremely fat fees are a problem; they can be offset by income that is higher than one will get from other stocks or bonds. He doesn’t recommend those nontraded trusts that carry too much debt.

He says that he always trained his salespeople to tell customers that the nontraded trusts are long-term investments. “There must be a 10- to 15-year time horizon, preferably 15. If you’re trying to redeem shares prior to the 10- to 15-year period, you are going to take a haircut. You have to go through several real estate cycles. Crap happens. And crap has now hit the real estate market.”

Attorney Rob Butterfield, who is often on the air with Ray Lucia, says, “You buy them as a bond substitute. They have potential upside, little downside, and even if [the price] goes down, you get that 5 to 6 percent a year, and you’re still ahead.” Some think of them as part stock, part bond, and part annuity, yielding 2.5 to 3 percentage points more than competing investments.

Theresa Ochs, head of compliance for RJL Wealth Management, says that Wells II “doesn’t take on a lot of debt. It is conservative. We as a firm pay close attention to the nontraded REITs we sell. We meet regularly with the principals.”

When Michael Lucia worked for Ray’s company, the firm paid $8175.21 to a customer who complained about not being informed of the risks in a Wells nontraded trust, according to Financial Industry Regulatory Authority records. “I had five different meetings with the investor, the kids were involved, the investor was fully aware that the REIT would be nonliquid for 10 or 15 years,” says Michael. But his then-boss, his brother Ray, decided to settle.

Regulatory authority records show that Michael Lucia personally understands how bad the real estate industry is. In July he filed for Chapter 7 bankruptcy because of a failed real estate investment. “The deal was not related to my financial planning practice. It was an investment in Las Vegas. When you buy it for $400,000, it’s worth $150,000, and your renter moves out, and you’re opening your own practice, you don’t have cash flow. I have eaten quite a bit of humble pie in the last four years.”

Florida-based White Law Group is investigating possible securities claims against brother Ray Lucia. The subject: the appropriateness of a nontraded real estate investment trust recommendation. The sale occurred back while Ray was still in the business. White says that the problem is that such investments “are often illiquid, and investors cannot readily access their money for unforeseen expenses (like medical expenses).”

That’s Jim Ketchum’s problem. He wonders if these long-horizon investments are really good for retirees. He will be 81 next month. “I bought these when I was in my mid-70s,” he says. He would like to think he will be alive when the 15-year period ends, but he is not putting any bets on it.

Of course, Ray Lucia doesn’t recommend that retired people put all their money in these trusts that will be illiquid for 10 to 15 years. People should put their funds in three “buckets,” he says. One can provide immediate income and liquidity. A second would concentrate in intermediate vehicles such as liquid bonds, and the third would be in the nontraded trusts, among other things.

However, Ketchum took a beating in the stock bear markets of the last 11 years, and he needs the funds in that last bucket but can’t tap them without taking a big loss.