The problems for Inland American Real Estate Investment Trust investors (one of the largest non-traded REIT in the U.S.) seem to continue. Just yesterday, the troubled REIT disclosed in its 2012 annual report filed with the SEC, that a number of investors have asked the REIT’s board to open an investigation for alleged breach of fiduciary duty and false share valuation reports. Specifically, the REIT disclosed the following in a filing with the SEC:
We have also received two related demands (“Derivative Demands”) by stockholders to conduct investigations regarding claims that the officers, the board of directors, the business manager, and the affiliates of the business manager (the “Inland American Parties”) breached their fiduciary duties to us in connection with the matters that we disclosed are subject to the Investigation. The first demand claims that the Inland American Parties (i) falsely reported the value of our common stock until September 2010; (ii) caused us to purchase shares of our common stock from stockholders at prices in excess of their value; and (iii) disguised returns of capital paid to stockholders as REIT income resulting in the payment of fees to the business manager for which it was not entitled.
The above should be of great concern, especially because investors are now beginning to ask the right questions as to share valuation methods as well as the excessive amount of fees investors are oftentimes subject to when investing in non-traded REITs. But a closer look into Inland’s annual report uncovers an even bigger problem that the approximately 185,000 investors may be unaware of that could drastically impact the already depreciated value of Inland American investor shares (which have declined over 30 percent).
First, the $10.8 billion REIT mammoth discloses that, as of December 31, 2012, Inland American had mortgage debt of approximately $5.9 billion. That represents a troubling 54 percent debt to asset ratio. Amazingly, the REIT’s authority to continue borrowing money is not limited until it reaches an unsustainable 300 percent. Specifically, under the heading “Borrowings may reduce the funds available for distribution and increase the risk of loss since defaults may cause us to lose the properties securing the loans” of its annual report, Inland American discloses:
We have acquired, and may continue to acquire, real estate assets by using either existing financing or borrowing new monies. Our articles permit us to borrow up to 300% of our net assets.
Inland American also reports that approximately $1.9 billion of its total indebtedness bears variable interest rates (that could skyrocket in the coming years). Moreover, approximately $882.9 million of the REIT’s debt matures this year. Although of great concern on their own, these numbers can represent an even bigger risk to investors if a handful of tenants were to default on their lease or if they were to terminate their leases.
As it turns out, Inland American has concentrated significant portions of the overall REIT in a handful of tenants, exponentially increasing the risk and heightening the possibility of further reductions in shareholder’s value. For example, Inland American reports that for the year 2012, Inland generated almost 20 percent of its overall rental revenue (excluding lodging, multi-family, and development properties) from only two tenants, SunTrust Banks, Inc. and AT&T, Inc. In fact, almost 40 percent of the REITs total rental income (37.64%) came from only ten (10) tenants. This significant dependency on only a handful of tenants is acknowledged by Inland when it stated that if either one of those tenants would cease to pay rent or fulfill its monetary obligations, the REIT could “significantly reduce rental revenues or higher expenses until the defaults were cured or the properties were leased to a new tenant or tenants.”
Geographic concentration is also another big problem for Inland American investors. Almost 30 percent of Inland’s total operation is concentrated in only four (4) metropolitan areas. The city of Houston alone represents more than twelve (12) percent of Inland’s overall rental income. Additionally, at December 31, 2012, forty-four (44) of Inland’s lodging facilities (approximately 50% of the lodging portfolio), were located exclusively in Washington D.C. Inland addressed such severe concentrations in its annual report by stating:
Geographic concentration also exposes us to risks of oversupply and competition in these markets. Significant increases in the supply of certain property types, including hotels, without corresponding increases in demand could have a material adverse effect on our financial condition, results of operations and our ability to pay distributions.
The last sentence used by Inland American, the “ability to pay distributions” is what the majority of Inland’s investors are currently concerned about. Despite the fact that Inland American has not yet suspended distributions, in 2012 approximately 82 percent of the declared distributions constituted a return of capital for tax purposes (i.e., a return on the investor’s original investment).
Regrettably, as investors become aware of all the red flags discussed above, their ability to sell their shares and get out of the investment are extremely limited. In 2012, Inland American’s board amended the REIT’s share repurchase program. According to its share repurchase program, Inland will only redeem shares in cases of death or qualified disability. And even at that point, redemptions would occur on a very limited basis (quarterly limitations) and at a price of $6.93 per share, not the original $10 per share value. In other words, in case of an allowed redemption for death or qualified disability, investors would immediately realize a loss of 30 percent of their investment.
For all remaining investors that do not qualify for the share redemption program, Inland American acknowledges that the $6.93 per share valuation (which will be re-priced again in December of 2013) could also be inaccurate. Inland American discloses that it cannot give assurances that “the methodology used to estimate [their] value per share would be acceptable to FINRA or that the estimated value per share will satisfy the applicable annual valuation requirements under…ERISA and the Internal Revenue Code of 1986…with respect to employee benefit plans subject to ERISA and other retirement plans or accounts subject to Section 4975 of the Code.”
The above signifies the type of problems Inland sponsored REITs have shown for a number of years. For example, approximately fifteen years ago, attorney Chris Vernon successfully recovered losses suffered by retirees as a consequence of their investments in the now-defunct Inland Monthly Income Fund III REIT. Presently, the law firm of Vernon Litigation Group is representing multiple investors for losses incurred when their broker improperly pitched them Inland American REIT as a safe investment suitable for their needs.
The Vernon Litigation Group’s investment fraud team of attorneys continues to represent investors nationwide who have suffered significant damages from REITs. Vernon Litigation Group’s investment fraud attorneys were among the first to caution investors about the dangers of non-traded REITs. They are currently representing investors nationwide who have collectively suffered more than $6 million in losses for investing in REITs like Wells, Cole, KBS, Behringer Harvard, Inland American, CNL, and Lightstone, among others.