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Growing Non-Traded REIT Industry

Posted: Thu May 17, 2012 5:45 pm
by NTRGUY
The NTR industry year after year is growing and bringing in more assets. Does this make you feel useless? you clearly haven't had a significant effect on anyone. Was this a complete waste of time? You bashed ARCT for years and they made you eat your words... I dont see any Inland Diversified dividend posts, i wonder why. Can't wait for CCPT2 to go full cycle and prove all your declining value and fake valuation talk to be bogus. Just because some companies suck doesn't mean the space is untouchable. Yes, sponsors charge too much in fee's, but that is changing as this is a new industry and takes time to evolve. The people who are making too much money in this transaction are the BD and the advisor. The pay to play theme is rampant in the NTR space. Advisors milk wholesalers for all the marketing support they can get. If you want to point a finger at someone taking fee's how about the avisor that requires a 2000$ dinner that they call a marketing event. Where do you think that 2000$ comes from Mr. Advisor, that's right, YOUR CLIENT. Marketing support should be disallowed and the commission to the broker lowered (it would be nice to see the commission drop dramatically for getting in the program near the close to stop the churning sales pitch employed by arc). The space has its downsides and black sheep, but the good sponsors provide enough benefits to help diversify a portfolio and achieve attractive risk adjusted returns. P.S. As a CFA charterholder i completely believe there are many client profiles that are suitable for this investment. Bottom line, there are some really bad reit's out there but also some good ones. The author clearly lacks the ability to distinguish between the two (ahem ARCT!), and should not be trusted for his clearly biased advice.

I hold no positions in any of the NTR's mentioned.

Re: Growing Non-Traded REIT Industry

Posted: Thu May 24, 2012 8:40 pm
by PEtrader
Very well said NTR.

Re: Growing Non-Traded REIT Industry

Posted: Fri May 25, 2012 1:10 am
by REIT Wrecks
NTRGUY wrote:The NTR industry year after year is growing and bringing in more assets. Does this make you feel useless? you clearly haven't had a significant effect on anyone. P.S. As a CFA charterholder i completely believe there are many client profiles that are suitable for this investment. Bottom line, there are some really bad reit's out there but also some good ones. The author clearly lacks the ability to distinguish between the two (ahem ARCT!), and should not be trusted for his clearly biased advice. I hold no positions in any of the NTR's mentioned.
My gosh, I'm so sorry for mixing everything up. Please forgive me. For some reason, I can't ever seem to keep stuff straight.

You have thoroughly shamed me. Hence forth I shall write no more.

P.S., I wish I were a "CFA charterholder", that might help my credibility.

Re: Growing Non-Traded REIT Industry

Posted: Fri May 25, 2012 7:30 pm
by REIT Wrecks
Now, NTR, as to the merits of your argument, you make some valuable points. Pay to play IS rampant. But the question I would ask is this: why are sponsors paying to play? (and if this is true, which it is, how could this possibly be a sign of a healthy, investor-friendly market?) In my humble opinion, as a non-CFA, I think the answer is that there is plenty of juice here for sponsors too, and the the non-traded REIT fee structure in general tends to be abusive. You don't need to be a CFA to add up the egregious loads, and to calculate the effect this has on investment returns. All things being equal, how are high fees, lack of transparency and conflicts of interest that are too numerous to count good for the average retail investor?

Not all sponsors are bad, but all sponsors are paid more to raise capital and deploy capital than they are to produce above-average investment returns. Investors are sucked in by a sales-driven yield that is in almost every case not covered by cash flow - not by a long shot. And advisors all love their 7% commissions (Daily NAV, anyone?). This leaves little margin for error, and if a sponsor turns out to be accident prone, investors are left holding the bag. But this is all ok, because sponsors disclose all of this in a prospectus that nobody reads. The examples of blowups happening, as you know, are much more numerous recently than the "success" produced by ARCT. Furthermore, I think it's fairly clear that a financial advisor who chose to invest client money in a comparable public REIT over the same period produced better returns for that client than if they had invested that money in ARCT, and with less risk (blind pool, lack of transparency, high fees, illiquidity, regulatory scrutiny, etc.). There is a long thread on ARCT that covers this in great detail, and it can be read here:

http://www.reitwrecks.com/forum/viewtopic.php?f=24&t=452" onclick="window.open(this.href);return false;

As for Inland Diversified, who knows? Same for CCP2. Have you read the latest Cole 2 prospectus supplement? I heard they disclosed about $300 million in transactions affiliates. Were the prices paid truly arms length? Who knows again. Of course, Cole says yes, but only time will tell, and in that supplement they also discuss their liquidity event. The language seems to be a lot more murky than before, and almost one year has elapsed since they announced that they were "actively" exploring such an event. So what's going on?? Until they sell, nobody knows what that portfolio is truly worth (RPAI), and a sale does not seem to be imminent. I would welcome your thoughts on this, and I do appreciate your posts. Nevertheless, it's a bit hard to see through all the finger wagging, and it tends to impugn your own credibility, in my humble opinion. Just sayin'.

Re: Growing Non-Traded REIT Industry

Posted: Fri May 25, 2012 10:22 pm
by NTRGUY
I actually agree with most everything you said. The fee's are too high, that is why many sponsors have been waiving the internalization fee and i suspect fee's will only get lower as the industry evolves. Both sides of this transaction do make a lot of money but there is no real alternative for the average investor. A traded REIT is too highly correlated to the market to have any diversification benefits in a down market. I'm not saying that during these times non-traded reit's don't have their own troubles but at least their value is based off of the value of the properties, and not swaying with market forces. A major benefit to the non traded vehicle that seems to be brushed aside is that the investor is not able to sell (besides redeeming) when values are down, which is as we know what almost everyone does. CPA 16 and CCPT2 both made money for every client invested in it during the worst market of the young century. The load, while i agree is too high, is what you pay for a true investment in real estate. Nobody said these are investor friendly, but they do serve a purpose. Yes, there is an inherent conflict of interest in that sponsors make more money by raising massive amounts of capital than they do by making large gains (the profit split is a joke and is just in there as a sales pitch because this is not where the sponsor makes their money). However the sponsors know that if they take money ahead of client's interest (the 300M inland took as an asset management fee on an underwater program is a great example) the sponsor in turn loses almost all their business. There have been way too many blow ups, and way more horror stories than successes, but that is because this vehicle is brand new and is taking time to evolve. There are now upwards of 40 non traded REIT sponsors and i think we will see the sponsors that adapt and make the necessary changes will survive and the rest will cease to exist. You can always find an investment that outperforms a non traded reit, but none will offer the diversification benefits during a down market that cole and wp carey's business model provides.

Re: Growing Non-Traded REIT Industry

Posted: Mon May 28, 2012 7:33 am
by CREInvestor1
The non-traded REIT industry is not new, it is just the continuation of the syndicated real estate partnership business that boomed in the 1980's and then collapsed when people started sueing the broker-dealers for selling busted lp's. If you look at the history and background of most of the NTREIT sponsors, they were syndicators in a prior life.

I think what ARCT accomplished is a) remarkable and b) not at all repeatable in the current environment. ARCT had the benefit of significant cap rate compression combined with very low leverage. The cap rate compression paid for the front end load and the low leverage allowed the fund to be it's own buyer in the ipo through that tender offer, absorbing the selling pressure and keeping the stock from dropping. I think that the ARCT team completed a very clever transaction and I give them full credit for executing it, but I think investors need to understand why ARCT was able to execute this and what actually happened and also realize how unlikely it is that other sponsors execute similar trades. The one fact to keep in mind with ARCT is that while it is now public, it did not raise any additional capital and has not attracted any new investors which will make for a fairly weak trading profile going forward.

Cole is nothing more than Inland 2.0 - they are really good at raising capital and either don't know or don't care that they are investing well below their cost of capital which will lead to substantial capital erosion over time.

Non traded REITs are sold because they pay a huge commission. There are good sponsors and bad sponsors, but the fact is it is a product built around a massive commission. Performance is always going to suffer versus similar funds because of the high load. There is no way to honestly defend that to a client.

Re: Growing Non-Traded REIT Industry

Posted: Tue May 29, 2012 7:51 pm
by NTRGUY
comparing a 10 million dollar LP and a 2.5 to 5 billion dollar NTR is far from apples to apples. It is the fee structure of the NTR that i referred to as new and it is the fee structure that has been adapting, and that in no way is similar to the LP's of the 80's.

Arct hit the timing perfectly and was able to ride cap rate compression to an EARLY exit. That doesn't mean they can't generate those returns again, they just won't do it nearly as quickly.

Next you said cole and inland buy at lower cap rates than their cost of capital. To this i say have you ever actually calculated cost of capital? obviously not, a 6% dividend with no growth rate and a borrowing rate of 5% with no tax write-off clearly under ANY weighting of the capital structure could you have a WACC that is greater than the average cap rate which is higher than 8 for both programs. Clearly you must be using a magical calculator.

Again the bottom line is, while another product may have greater returns over a specific period of time, none will have lower correlation, especially during a down period (when it is most important), than a NTR. This fact is statistically proven and undeniable.

Re: Growing Non-Traded REIT Industry

Posted: Wed May 30, 2012 9:02 am
by CREInvestor1
You should do some research on the partnership era - there were huge multi-billion diversified partnerships as well as single asset transactions. The industry was massive and peaked in the late 1980's at an annual fund raising pace that significantly eclipses today's NTREIT industry in inflation-adjusted dollars. You mentioned CPA:16 as a successful fund. It's predecessors CPA:1 - CPA:9 (employing an identical fee structure and strategy) were all syndicated partnerships dating back to the 1970's. That series of partnerships was actually quite successful (see the CPA:17 prospectus) but the sponsor switched to the NTREIT structure when LP's became a bad word in the investment world. If you dig into the background of NTREIT sponsors, the majority were LP syndicators in their former lives.

As a CFA, I encourage you to put that analytical firepower to work calculating the investment return required to 1) deliver an investor a 6% dividend over 7 years 2) get the investor's full principal back at the end of the term 3) pay the front-end load and 4) pay the sponsor's fee structure and ongoing expense reimbursements. Using Cole as an example you need to generate a 12.5% IRR to deliver a 6% dividend and get the investor their money back. Each NTREIT has its own fee structure so they vary up and down but this is a good ballpark. Total fee dilution is 500 bps - 700bps depending on the fund; this number excludes any backend performance fee or internalization.

Take a look at a sample of transactions that one of these NTREITs completed over the past 12 months. I don't mean to keep picking on Cole, but they give the best asset-level disclosure and have also been one of the most active acquirers across a wide range of asset types. Pick a couple of their large net lease transactions (easier to analyze) and take a look at how their net rents compare to market rents for similar buildings. Next model out the investment and look at what residual ($/sqft) you need to assume at the end of the lease term to realize a 12% return. Next, compare that $/sqft to similar assets in the market that don't have the benefit of a 10+ year lease. Next model the transaction using realistic residual assumptions, and you will see that much of the activity does not come close to meeting a 12%+ cost of capital hurdle.

You will say "but the NTREITs are paying for the benefit of a long lease" which is true, but if your long term lease is at above-market rents, then a portion of that rent is actually amortization (like in an equipment lease). This does not make it a bad investment provided that you are a) provisioning for this amortization by building up cash or paying down debt in an amount that offsets the cumulative depreciation, or b) explaining to your investor that a portion of their principal is being repaid to them over the life of the investment so they will not be getting their full principal back.

The problem with the bulk of the NTREITs out there is that they are sold with a promise of a stable dividend and protection of principal, but they have dividends that are unsustainable based on the current yield of the assets in the portfolio (the dividend coverage calculation that REIT Wrecks correctly focuses on), and they are buying assets that have inherent amortization but are making no provision for this decline in value over time (this is harder to quantify and requires an understanding of specific assets and markets). In the old days, debt amortization provided a nice forced savings which offset this amortization, but most NTREITs are now financed with I/O debt which never pays down so the value of the lease burns down but debt stays the same slowing increasing the inherent leverage of the portfolio and eating away at the equity base of the fund. Most of the NTREITs appear to be managing to that current yield and not worrying about the long term impact to their equity base. They can get higher cap rates on assets with above market rents and thus make their dividend coverage look better. Some can't even get to a covered dividend, let alone worry about the long term NAV which is another issue altogether...

Over the past couple of years, sponsors woke up to discover that the conservative 50% - 60% LTV balance sheet that they used when they constructed the portfolio is suddenly 70% - 80% and they can't refinance it at reasonable rates. At that moment the fund faces a cash crunch. Dividends get cut, redemptions get suspended and there is an ugly realization that the equity base has been significantly eroded crushing the per share NAV. While an exogenous market correction did temporarily impair the value of commercial real estate assets, most markets have substantially recovered, and the funds with significantly impaired NAVs lost most of the value through over-distribution, redeeming shares above true NAV, and inherent depreciation in the assets they acquired. Most of the value has been lost forever and will not be recovered by a further recovery in the commercial real estate industry.

You make a very good point that sponsorship is paramount to the quality of the fund they manage. My only caution is that most of these sponsors are sales organizations that are really good at raising capital with a slick sales pitch that strikes a chord with today's retail investor (current income and capital preservation). The reality is that many of these funds have almost no chance of actually delivering on these investment goals. When looking at a sponsor ask - How many funds has the sponsor actually realized an exit on? How big is the current fund versus the funds that they managed in the past? What strategy are they actually executing? Does it make sense? What experience does the team have in that strategy? We are in a yield starved environment so what risks are they taking to generate yield (credit risk, real estate risk, interest rate risk, country risk).

If you believe that commercial real estate assets are going to experience significant appreciation in value than you are much better off owning a public REIT with a similar strategy. The quality public REITs tend to own better assets, and their expenses are much lower. Just like in the NTREIT space, there are good and bad public REITs, its just that the bad ones tend not to be able to raise capital while the bad NTREITs seem to be able to raise capital regardless of track record. The correlation argument for NTREITs is preposterous. If NTREITs are assuming a public market exit, then the ultimate return realized by the investor is HIGHLY correlated with the performance and values of public REITs. the only difference is that you don't get the benefit of liquidity during the term. The lack of correlation should be recharacterized as a lack of disclosure.

How about this - you give me $1,000 and I will but some tech stocks with it. I will hold the stocks for 10 years and decide what I think the underlying companies are worth at the end of each year and report an account value to you. At the end of 10-years, I will sell the shares and give you the money back. What is the correlation of that trade?

If you are interesting in diligently researching NTREITs, talk to anyone in the commercial real estate industry (broker, investor, owner, developer, research analyst), and ask them about the current investment environment, expected returns and what they think of the various NTREITs as investors. I think the feedback you will get will be extremely helpful in understanding the differences in sponsors, and evaluating the asset class overall.

Disclosure - I work in the real estate industry but do not own any NTREITs, and do not plan on doing so in the future

Re: Growing Non-Traded REIT Industry

Posted: Wed May 30, 2012 1:25 pm
by NTRGUY
your calculation of the fee's being 500-700bp's is flat out wrong and so is the 12.5% IRR. There is no basis for calling the leases above market rent's. 1 all other REIT's traded and non traded are paying roughly the same cap rates as cole does for the quality tenants they invest in. 2 the average cap rate is above the MIT cap rate for comparable properties so these leases are in fact a bargain for the type of credit quality tenants (look at the microsoft lease with a 6% initial cap rate with 10% rental increases every 5 years for a AAA rated company). The value in these triple net leases is the 1.4% per year average rental increase (CCPT3 Portfolio), which is in the contract that is corporately guaranteed. Even if you were to keep cap rates constant these rental increases would not only increase the cash flow but are guaranteed capital appreciation (with constant cap rates). If you looked at investors who invested in traded REIT's over the last 5 years i bet the majority of them actually lost money because most people sell low and buy high. The NTR vehicle allows an investor to ride out these tough times. EVERY SINGLE INVESTOR in CPA 16 and CCPT2 over the last 5 years has made a profit. There is no way in hell that ANY traded REIT (or tech stock) over the last 5 years had EVERY investor make a profit. The value in NTR's are that you do not need to act like you can predict whether the CRE market is appreciating or depreciating, all you need to do is pick a good strategy that will perform regardless. This is why people invest in NTR's and if you can't understand it than don't invest in it, but many people do, and that is why the industry is growing.

Re: Growing Non-Traded REIT Industry

Posted: Wed May 30, 2012 10:50 pm
by REIT Wrecks
NTRGUY, you've really missed the mark here, in my opinion. As CREinvestor1 points out, the partnership era was much bigger and more damaging than you seem to know. Take the time to read the below excerpt from Kurt Eichenwald's "Serpent on the Rock". The parallels are not direct (NTRs are not frauds), but tale is entertaining, chilling, and telling. Chicago-based VMS Realty Partners was one of the leading players in this business before it all blew up; they raised over $1 billion across several funds. This is the industry that helped give birth to Non-Traded REITs. Do yourself a big favor and read the whole excerpt:

http://www.businessweek.com/chapter/chap0003.htm" onclick="window.open(this.href);return false;

After you've read that, take the time to read Section II A of [url=http://www.sec.gov/litigation/aljdec/id134cff.txt]this 1999 SEC order regarding, among other things, certain sales of a VMS mortgage fund[/url]. In the "Findings of Fact", the order states: "The limited partnerships were illiquid and speculative, and many investors did not understand that the cash distributions they received included return of capital as well as current yield [emphasis mine]. Limited partnerships paid commissions up to eight times higher than commissions for standard equity securities.".

Does this sound familiar?? If so, not only is there is nothing "new" about the non-traded REIT fee structure, it also seems pretty clear that the industry has failed to adapt at all.

As for your WACC summary, investment portfolios need to generate a yield in excess of the WACC, not the other way around. In order to arrive at a proper WACC for Cole, you would need to fully load the cost of Cole's capital for equity fees and commissions, not just for the cost of Cole's debt and their fake, heavily dilutive dividend. Fully loaded, my guess is that Cole's 8% acquisition cap rates would be buried by a WACC somewhere between 10-12%. Combine that with triple net lease terms that are burning off as we speak (and eroding asset value in the process), and you're pushing a big rock up a steep hill.

Finally, the low correlation you speak of is NOT "statistically proven and undeniable". In truth, it is nothing more than a fiction engineered by NTR sponsors and their "third-party" due diligence errand boys. In the absence of full liquidity, the $10.00 fixed share price is just a big hoax, and Inland Western/RPAI proved that resoundingly.