Preferred Apartment Communities Inc.’s Nontraded Preferred Shares May Carry Risks for Investors

According to a recent InvestmentNews article, Preferred Apartment Communities Inc. began selling an investment known as a Nontraded Preferred Share after 2011.  The article detailed that the investment is redeemable back to Preferred Apartment Communities Inc. after five years, and if the investor needs to redeem it before five years, they must pay a redemption fee that decreases over time.  If the investor seeks to redeem during the first year, the redemption fee is 13%, according to the article.

Nontraded REITs (Real Estate Investment Trusts) have long been an area of concern for securities regulators like the Financial Industry Regulatory Authority (FINRA) because they are generally illiquid investments that pay high upfront commissions to the brokers who sell them.

Nontraded REITs pose suitability concerns for investors.  Brokers who recommend them must make sure the investors are not over-concentrated in the investment, and that they have disclosed all of the risks associated with them, including the investment’s illiquid nature and the high fees earned, leading to questions of whether the investment is in the best interest of the investor.

The InvestmentNews article noted that Preferred Apartment Communities Inc.’s nontraded preferred shares earns brokers who recommend them a 7% commission, as well as an additional 4-5% in broker-dealer fees and offering costs, much like Nontraded REITs, and that the investment is listed at the investment price on their account statement.  Until very recently, nontraded REITs were also generally listed at their offering price, or “par” value on investors’ statements.

The nontraded preferred shares appear to have similar qualities as Nontraded REITs.  According to the article, the nontraded preferred shares from Preferred Apartment Communities Inc. are illiquid and nontraded and are redeemable only back to the company.  To avoid a redemption fee, investments must wait a long period of time (five years) to get their initial investment back, unlike regular common stock that can generally be sold on a national exchange at a price determined by the securities market, which can rise or fall.

The same suitability rules apply to the recommendations by brokers to investors of these nontraded preferred shares as apply to most other securities.  FINRA Rule 2111 requires that a broker recommend only investments that are suitable for each investor, based on that investor’s specific experience, wealth, age, and investment experience, as well as other factors.  FINRA Rules also require that investors be informed by their broker of all risks pertinent to investments.

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