Desert Capital REIT Inc. Investigation

October 11, 2011

Salas Wang LLC currently represents several investors that have invested in Desert Capital REIT Inc. for claims against brokers, broker-dealers, and financial advisors.  If you have invested in Desert Capital, please read below:

Background

Desert Capital Inc. was a Henderson, Nevada based non-traded REIT.  A non-traded REIT acts as a private company owned by an amalgamation of unrelated investors. The commissions and fees on these REITs can be up to 17% of the investment, with the promise of large dividends. The problem with a non-traded REIT is the same as the problem with owning private company stock–there is no active market for the shares.  So, if the REIT decides to stop paying dividends and/or decides to not redeem shares in cash, the shareholder is stuck with the illiquid investment.

Desert Capital’s Risks

Desert Capital was especially risky, and its ultimate demise has been well documented.  Specifically, Desert Capital was an investment that made short-term sub-prime loans to builders and developers.  According to Desert Capital’s 10-K published just before Spears’ investment, the REIT “frequently invest[s] in sub-prime, or non-investment grade loans, which may be made to borrowers with limited credit histories.”  Desert Capital REIT Inc., Form 10-K, April 2, 2007.   Desert Capital’s 10-K also listed numerous risk factors that show that this is not a suitable investment for investors that need safety and liquidity, specifically:

  • No Investor Oversight:  We are a blind pool REIT and you will not have the  opportunity to evaluate the manner in which we invest or the economic merits of particular assets to be acquired. p. 9.
  • Investing in uninsured and non-investment grade mortgage loans as part of the investment strategy: “In order to grow our business, we may also invest in loans to borrowers who have a high risk of not being able to repay their obligations on a timely basis.” p. 10.
  • A Majority of its Assets had “Balloon” Payments:  “We expect balloon mortgage loans to continue to comprise substantially all of our investment portfolio. If the borrowers are unable to refinance the loan or sell the property when the balloon payment is due, our revenues will decrease. Balloon payment loans do not generate principal repayment to us through monthly repayment.”  Id.
  • Investments in Sub-prime Loans:  “Many of the loans in which we invest are sub-prime loans made to borrowers with limited credit histories and are riskier than investment-grade loans because there is an increased possibility that the borrower will not be able to repay the principal at maturity. We expect that sub-prime loans will continue to comprise a majority of our investment portfolio.” Id.
  • Loans that are Subordinate to Other Loans:  “We acquire loans secured by commercial properties, including loans that are subordinate to first liens on the underlying commercial real estate. Subordinated, or second lien, mortgage loans are subject to greater risks of loss than first lien mortgage loans because all payments on these loans are subject to the prior payment of the senior loan.”  Id.
  • Loans to borrowers for unimproved land:  “We expect that up to 50% of our assets will continue to be mortgage loans for the acquisition and development of real estate, which will initially be secured by unimproved land. These types of loans are highly speculative, as the borrower’s ability to repay depends on its ability to develop the land.”  Id.
  • Refusal to geographically diversify:  “As a result of our geographicconcentration, we may experience more losses than if our investments were diversified. A worsening of economic conditions in Las Vegas could have an adverse effect on our business, including reducing the demand for new financings, limiting the ability of customers to pay financed amounts and impairing the value of our collateral.”  p. 12.
  • Relying on Third Parties to Adequately Appraise Property:  “Our decisions about which loans to fund depends on several factors, such as the third party appraisal of the property involved and our analysis of the financial position of the borrower. If the appraiser makes an error in the appraisal, or the borrower or its accountant makes an error or a misrepresentation in the information provided to us, we will make our decision based on faulty information, which may lead us to invest in an asset which is not within our standard investment criteria.”  Id.
  • Holding on to Potentially Bad Investments:  Because most of our loans are short-term, with 12-18 month maturities, we will generally hold our investments to maturity. However, until approximately 2011, to the extent we sell any mortgage loans or property acquired in foreclosure, we intend to use any proceeds from those sales not required to be distributed to stockholders in order to preserve the our status as a REIT to fund or acquire additional mortgage loans and repay outstanding indebtedness.  Id.
  • Novice Management Team:  “Our management team has limited experience managing a REIT.  Our management team has experience managing a REIT since our commencement of operations in August 2004. Because of management’s limited REIT experience, we might not be able to successfully implement our operating and investment policies.” Id.

As these risk factors show, this investment is only suitable for the most savvy investors.  Many brokers sold customers this investment without disclosing the enormous risks that Desert Capital was taking with investors’ money.  The reason Desert Capital’s sale was so pervasive was because it paid very generous commissions to brokers that sold the investment.

If you invested in Desert Capital, and would like to explore your recovery options, please call Jeffrey Salas at 312.803.4963 or fill out the contact form below.

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