The Direct Participation Program (DPP) is a non-transactional collective investment that invests in real estate or energy-related companies that are seeking capital for a long time. DPP has a limited life span, generally 5 to 10 years, and is often a passive investment. According to a recent CNBC article, DPP is “becoming an alternative asset class for retail investors, typically generating a 5% to 7% income stream.” In today’s low interest rate environment, this income stream is very attractive.
What is DPP, what should investors and financial advisors know before investing?
Most DPPs provide investors with income streams from underlying companies. These dividend payments may come from real estate rental payments, mortgage payments, equipment leases, oil and gas lease payments, or other income streams based on DPP’s underlying business.
Investor Participation Rules
The restrictions on investors who are eligible to invest in DPP will be different. Income and net assets usually have a minimum. In some cases, the DPP will comply with the accredited investor rules of the corresponding state and the Securities and Exchange Commission (SEC). In addition to restrictions on who can and cannot be invested by appropriate regulatory agencies, each DPP plan may also have additional restrictions. These restrictions are usually due to the illiquidity of DPP rather than its investment risk.
DPP investors need to understand that these are illiquid investments. They need to be prepared to invest their funds for many years, usually until the investment is liquidated and the investor’s funds and any previously unpaid proceeds are distributed to them. Non-trading REITs are an example. They usually make distributions, but investors cannot get the funds until the fund is publicly listed or the fund is liquidated. The illiquidity of DPP may be an advantage in the market turmoil we are currently experiencing.
Transaction and non-transaction
DPP is mostly a non-trading investment tool. 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 non-existent. Keith Allaire, managing director of investment bank and DPP industry consultant Robert A. Stanger & Co., stated in a CNBC article: “Trading products tend to focus on market sentiment, rather than trading products focusing on the value of underlying assets.”
According to CNBC’s article, the most common types of DPP currently are:
- Unlisted REITs-approximately 65% of the DPP market
- Non-listed business development companies (BDC), which are debt instruments for small businesses—approximately 32% of the market
- Oil and gas plans, such as royalties or tax breaks
- Equipment leasing plans for various industries
The Investment Planning Association compiled some industry statistics as of the end of 2014:
- More than 30,000 financial advisors have used unlisted REITs or BDCs in their practice.
- More than 1.2 million investors have unlisted REITs or BDCs in their portfolios.
- The average account size is approximately US$16,900.
- 43% (or US$9.2 billion) was invested through qualified accounts.
In recent years, non-trading REITs have been criticized by the US Securities and Exchange Commission and other institutions. In August 2015, the US Securities and Exchange Commission issued an investor announcement. As the person in charge of a local private real estate investment fund told me, just because investors have performed well in investments such as non-trading REITs, it does not mean that it is a suitable investment for them. Several major broker-dealers have imposed restrictions on the use of non-trading REITs.
Is DPP suitable?
In most cases, financial advisors want to do what is most in line with the interests of their clients. This means helping them achieve long-term and short-term financial goals. For investors who are looking for income and have the ability to invest part of their portfolio in investment vehicles that lack liquidity, investing in DPP products may be a good way.
In terms of their nature, many DPPs have relatively low correlation with traditional long-term investments in stocks and bonds, so they can be used as alternative investments. In the current turbulent investment environment that we have seen in the past year, people have renewed interest in all types of alternatives.
Financial advisors must conduct appropriate due diligence on these products, not just whether the DPP meets the applicability criteria. They, or at least their company, should thoroughly review those who provide the investment and their track record, as well as the economic arguments for the investment.
Some people declare DPP as a new asset class. They can provide stable income and cash flow, which is ideal for many investors. Financial advisers are responsible for ensuring that any DPP is suitable for their clients before recommending them as an investment option.