Direct Participation Programs: Can You Trust Their Underlying Investments?

Direct Participation Programs (DPPs) are investment vehicles that allow investors to pool their money in business ventures that do not trade on a public exchange. They’re also known as “private placements.” Investors might hear about advantages like cash payouts and tax benefits, but financial advisors should also make sure investors are aware of the significant risks.

DPPs often invest in non-traded Real Estate Investment Trusts (REITs). These are alternative investments that can make high returns even as the stock and bond markets lag. You may also hear alternative investments referred to as “Non-correlated assets,” because they do not correlate with the stock market. These types of investments get a boost in popularity when the stock market is volatile.

How Direct Participation Programs Works

Direct participation programs often invest in oil and gas or real estate, both markets that are subject to profound fluctuations. Other common DPPs include agricultural programs, cattle programs, or condominium securities. Most DPPs — approximately 65% of the market — involve Real Estate Investment Trusts (REITs).

· Direct participation programs have a sponsor and a manager, much like a mutual fund. The manager assesses risk and makes the big decisions about how to invest.

· They invest in private companies that do not have to disclose their financials. Investors often don’t know what’s happening behind the scenes and have no control over the businesses’ management.

· For some DPPs, investors must be accredited investors, meaning that they have an especially large income or high net worth. Other DPPs still have some income requirements — usually, investors must have an annual income of $70,000 or a net worth of $250,000.

· Most DPPs mature over a period of five to 10 years. During that time, they are illiquid, meaning that investors will not be able to get their money out without paying fees.

Investors might find Direct Participation Programs attractive because of their flow-through tax consequences and regular dividend incomes.

· Flow-through tax consequences: Instead of paying corporate taxes, DPPs members only have to pay income taxes.

· Regular dividend income: Successful DPPs can typically generate returns of approximately 5% to 7%. In real estate DPPs, that income comes from rent payments or mortgages.

Are Direct Participation Programs Risky?

Beware of the information you learn from Direct Participation Program “seminars.” Free-lunch seminars have a reputation for focusing on the possible benefits of an investment, and not the risks. This may be because DPPs typically come with significant commissions for financial advisors. Before you sign on the dotted line, make sure you ask how much your financial advisor makes from the sales of DPP shares. Keep in mind that there are plenty of six-figure investor disputes involving Direct Participation Programs.

If the DPP’s underlying business venture doesn’t work out, or if it simply costs too much to operate, the limited partners could lose their capital. As we saw with Covid-19, unpredictable factors can cause the sudden collapse of rent-dependent businesses like REITs. Investors looking at DPPs for diversification and regular payouts may want to consider lower-risk investment vehicles.