United Development Funding IV, a Texas-based real-estate investment trust (REIT), has fallen more than 50% in the last 24 hours.
On Thursday afternoon, UDF’s stock fell 35% after an anonymous short-seller published a report on an investing website that said the company is operating a “Ponzi-like real estate scheme.”
Shares of United Development Funding, a non-traded REIT, fell $6.05, or 35.17%, to end the day at $11.15. On Friday, the stock fell further, last trading down around 30% at $7.88 per share.
The short thesis that sent shares plummeting was posted by someone under the pseudonym “Investor For Truth” on the Harvest Exchange, a website where hedge fund managers and investors can post their investment ideas.
The thesis was posted on Thursday morning. The stock collapse happened in the afternoon once value-investing blog ValueWalk reported that it believes the short-seller behind the report is J. Kyle Bass of Hayman Capital.
In a statement released late Thursday evening, the company said “a hedge fund has created a significant short position” in its stock.
“We believe that this hedge fund is trying to unlawfully profit by manipulating and depressing the price of United Development Funding IV shares,” the company said.
The company also said that it’s been cooperating with the SEC in a “fact-finding investigation.”
The Companies have been cooperating since April 2014 with a nonpublic fact-finding investigation being conducted by the Staff of the Securities and Exchange Commission (the “SEC”). The SEC has informed the Companies that this investigation is not an indication that any violations of law have occurred or that the SEC has any negative opinion of any person, entity, or security. We believe that the Companies have appropriate policies and procedures in place to ensure accurate financial reporting and compliance with all applicable rules and regulations. While it is not possible to predict the timing or outcome of the SEC fact-finding investigation, we believe that this matter will not have a material adverse effect on the Companies’ consolidated results of operation, financial position, or liquidity.
The short seller report
In the first report, the short seller said that the low-interest rate environment for the past six years has been the main driver of growth in the non-traded REIT asset class. In 2015, the Securities and Exchange Commission named non-traded REITs as one of the five most serious problems affecting retail investors.
Non-traded REITs are public because they reach the minimum threshold of shareholders to be considered public. They’re not liquid investments, the short seller said.
“In reality, an investment in a public non-traded REIT is typically an investment in an illiquid ‘start up’ real estate company that must accumulate assets quickly and is subject to the same market risks (or greater market risks) as its publicly traded, more liquid peers which benefit from lower costs of capital,” the short-seller wrote.
The short-seller said that it’s the unsuspecting “mum and pop” retail investors, who are seeking yield in the low-interest rate environment, that get pitched to invest in non-traded REITS by financial advisors. These financial advisors are incentivized to sell non-traded REITS by getting paid commissions from the company, the report said.
United Development Funding is a mortgage REIT that lends money to develop properties and charges interest on the loans.
UDF I was a real-estate lender and real-estate developer in the years leading up to the financial crisis. However, UDF I began to default on its debt and used United Mortgage Trust (UMT) to provide liquidity for UDF I, according to the report. As that problem continued, UDF III came along and then UDF IV, the report said.
The short-seller said that the company has raised over $1 billion for four different public entities.
The company partnered with brokerage firm RCS Capital (RCAP) to raise money from retail investors for UDF IV. RCS Capital was paid commission fees for selling the REIT to retail investors.
The short-seller alleged that UDF IV has since used that money to provide liquidity for UDF I and UDF III. Right now, UDF V is being used to provide liquidity to UDF IV, according to the report.
The short seller wrote that “cracks in UDF’s facade are starting to appear.”
“On or about October 30, 2015, a lawsuit was filed in Travis County, Texas naming UDF IV as a co-defendant in a case involving allegations of fraud, breach of contract, tortious interference and fraudulent transfer. On November 24, 2015, UMT, UDF, UDF III, UDF IV and UDF V each filed Forms 8-K revealing that their independent registered public accounting firm, Whitley Penn LLP, declined on November 19, 2015, to stand for reappointment as the auditor for each company. On the same day that it was announced to public shareholders that Whitley Penn had declined to stand for reappointment, William Kahane (who appears to be affiliated with RCS Capital, AR Capital and Nicholas Schorsch) resigned from UDF V’s board. On November 20, 2015, UDF III filed an involuntary bankruptcy petition in the United States Bankruptcy Court for the Western District of Texas against UDF III and UDF IV’s second largest non-affiliated borrower.”
We reached out to UDF again to address the specific allegations in the report. We’ll update when we hear back.
The anonymous short-seller on Friday published a second report, in which it claims to prove UDF has been providing liquidity to affiliates.
Here’s a chart:
NOW WATCH: How ISIS makes over $1 billion a year
Business Insider Emails & Alerts
Site highlights each day to your inbox.