FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client is considering investing in a real estate direct participation program (DPP) focused on raw land. Which of the following risks is MOST prominent for this type of investment?
- ADepreciation recapture
- BLack of liquidity
- CPhantom income
- DHigh management fees
Show answer & explanationAnswer & explanation
Correct answer: B. Lack of liquidity
Direct Participation Programs (DPPs), especially those investing in illiquid assets like raw land, are highly illiquid. There is no active secondary market, making it difficult to sell the investment quickly or at a fair price.
Why the other options are wrong
- A. While a risk in real estate DPPs, depreciation recapture primarily applies to income-producing properties, not raw land which cannot be depreciated.
- C. Phantom income is more common in oil and gas DPPs or leveraged real estate, but less so for raw land which typically doesn't generate income.
- D. High management fees are common in many DPPs, but lack of liquidity is a more fundamental and significant risk for raw land investments specifically.
DPP Liquidity Risk
Direct Participation Programs (DPPs) are generally illiquid investments, meaning there is no active secondary market for units, making them difficult to sell quickly or without significant loss.
- Common characteristic of most DPPs.
- Units are not easily transferable.
- Investors must be prepared to hold the investment for the long term.
- Risk is particularly high with raw land due to lack of income.
Memory trick: DPP Risks: Don't Participate Poorly, Prepare for Problems.