Direct participation programs (DPPs) are non-traded, pooled investments that invest in real estate or energy-related ventures that are seeking funds for an extended period of time. DPPs have a finite life, generally five to 10 years and tend to be passive investments. According to a recent CNBC piece, DPPs “are emerging as an alternative asset class for retail investors, typically generating an income stream of 5% to 7%.” In today’s low interest rate environment, this type of income stream is attractive.
What are DPPs and what do investors and financial advisors need to know about them before investing?
Most DPPs provide investors with a stream of income from the underlying venture. These dividend payments might arise from real estate rental payments, mortgage payments, equipment leases, oil and gas lease payments, or other income streams based upon the DPP’s underlying business.
Investor Participation Rules
The restrictions on investors who are eligible to invest in DPPs will vary. There are generally minimums for income and net worth. In some cases, DPPs will fall under the accredited investor rules for the appropriate state and the Securities and Exchange Commission (SEC). Each DPP program may also have additional restrictions over and above those of the appropriate regulatory body restricting who can and cannot invest. These restrictions are generally in place due to the illiquid nature of DPPs rather than based upon their investment risk.
Investors in DPPs need to understand that these are illiquid investments. They need to be prepared to keep their money invested for a period of years typically until the investment liquidates and distributes investors' money back to them plus any gains not previously paid out. Non-traded REITs are an example. They generally make distributions but money is not available to investors until the fund lists their shares publicly or liquidates the fund. The illiquid nature of DPPs can be an advantage in turbulent times in the market such as those we are currently experiencing.
Traded vs. Non-Traded
DPPs are mostly non-traded investment vehicles. They are not traded on the New York Stock Exchange or any similar public investment exchange. The secondary market for these investments is limited or nonexistent. Keith Allaire, managing director for Robert A. Stanger & Co., an investment bank and advisor for the DPP industry said in the CNBC piece: "traded products tend to focus on the sentiment of the market, while the untraded ones focus on the underlying value."
According to the CNBC piece, the most common types of DPPs currently are:
- Non-listed REITs—about 65% of the DPP market
- Non-listed business development companies (BDCs), which are debt instruments for small businesses—about 32% of the market
- Oil and gas programs, such as royalties or tax deductions
- Equipment-leasing programs in various industries
The Investment Program Association compiled some industry statistics through the end of 2014:
- More than 30,000 financial advisors used non-listed REITs or BDCs in their practices.
- More than 1.2 million investors had non-listed REITs or BDCs in their investment portfolio.
- Approximately $16,900 was the average account size.
- 43% (or $9.2 billion) was invested through qualified accounts.
Non-traded REITs have come under fire in recent years from the SEC and others. In August of 2015, the SEC published an investor bulletin. As the head of a local private real estate investment fund said to me, just because the investor did well in an investment like a non-traded REIT doesn’t mean that it was an appropriate investment for them. Several major broker-dealers have placed restrictions on the use of non-traded REITs.
Are DPPs Appropriate?
Financial advisors for the most part want to do what is in the best interests of their clients. This means helping them achieve their financial goals, both long and short term. Investing in DPP products can be a good route to take for some investors who are looking for yield and who have the ability to invest a portion of their portfolio in an investment vehicle that lacks liquidity.
By their nature, many DPPs serve as alternative investments via their relatively low correlation to traditional long investments in stocks and bonds. In the current volatile investing environment that we’ve seen over the past year, there is a renewed interest in alternatives of all types.
Financial advisors must do appropriate due diligence on these products and go beyond whether the DPP simply meets a suitability standard. They, or at least their firm, should fully vet those offering the investment and their track record, as well as the economic thesis of the underlying investment.
The Bottom Line
DPPs have been proclaimed a new asset class by some. They can offer a solid yield and cash flow stream which is very desirable to many investors. It is incumbent on financial advisors to ensure any DPP is right for their clients before suggesting them as an investment option.