Cole REIT Has Dividend Problems

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Cole REIT Has Dividend Problems

Postby REIT Wrecks » Sat Apr 17, 2010 2:14 pm

In 2009, Cole REIT II reported only $117 million in GAAP cash flow, yet somehow managed to distribute $135 million in dividends. If you're a shareholder, you would have had no cause for alarm. The dividends landed magically in your account as always, no checks bounced, and the payment date was not delayed by even a minute. Clearly, those distributions were money good. But whose money was it and where did it come from? More importantly, isn't distributing more than you earn a bit of a problem?

Many people think it is, including the Financial Industry Regulatory Authority ("FINRA"). FINRA is an independent regulatory organization empowered by the federal government to "ensure that America's 90 million investors are protected". Of course, that very mission begs the question protected from whom?, but for better or worse FINRA's chief role is to protect investors by maintaining fairness in the US capital markets. FINRAs role is broad and important, and among other duties, FINRA regulates many aspects of non-traded REITs like Cole REIT II.

Almost 12 months ago, FINRA issued Notice 09-09, which incorporates non-traded REITs specifically, and it states that:

paying dividend distributions that are unsustainable over the long term due to cash flow difficulties presents a significant risk to investors' future returns and the long-term viability of the program

In short, this is a problem if you're like most of us and you actually want your money back someday. In fact, not only is Cole REIT paying dividend distributions in excess of cash flow, but its cash flow difficulties seem to be getting worse. Cole REIT II's earnings have been declining, and on on November 10, 2009, Cole's board of directors suspended the Company's share redemption program indefinitely. Basically, this means that Cole REIT II no longer has the cash to honor its share buyback program.

Cole REIT II has not always paid dividends in excess of cash flow, and it's certainly possible that they'll be able to fund distributions from operating cash flow in the future. However, this may be unlikely given Cole's past practice. Over the past three years, Cole reports that over 50% of the dividends were paid simply by returning shareholders' own money.

Sadly, the practice of inflating dividends is a common tactic in the non-traded REIT world (see REISA Addresses Non-Traded REIT Ponzi Scheme Allegations), and it's done mainly to help sell more shares. While paying inflated dividends may be an incredibly effective marketing gimmick, it's also incredibly harmful to shareholders. To the extent that shareholder funds are not invested in income producing property, overall shareholder returns are irrepairably harmed. Indeed, Cole itself says this tactic may "substantially reduce" current returns and capital appreciation. In its 10K, Wells REIT II, a competitor of Cole's, describes the problem this way:

we may fund our distributions from borrowings or even the net proceeds from our ongoing public offering. If we fund distributions from financings or the net proceeds from our public offering, we will have less funds available for the acquisition of properties, and the overall return to our investors may be reduced

Non-traded REIT financial statements are complex and difficult to understand, but it's not difficult to understand that dividends must come from cash flow. To the extent that they do not, on a long term basis, it's a big problem and management is putting shareholder returns in great jeopardy. Whether Cole REIT shareholders ever enjoy positive overall returns remains to be seen, but frankly, management owns almost no shares and nobody is paid to worry about overall returns.

Since inception, Cole REIT II has paid management $65.9 million in acquisition fees, $18.8 million in financing fees, $16.3 million in organization and offering costs, and $17 million in asset management fees, on top of $135.5 million in commissions and fees paid to stock brokers and financial advisors. That's a $252 million bonanza just for paying shareholders back with their own money. When the music stops, one wonders, how could there be anything left for investors?

Related Posts:

Cole REIT III "Wholly Inappropriate" Says Advisor
Can't Trust Cole Credit Property Trust III
Cole REIT Redemption Flip Flop: Are Some Investors Special?
Non Traded REITs Are Designed to be Sold, Not Bought

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Re: Cole REIT Has Dividend Problems

Postby bobsmith » Wed Apr 28, 2010 9:40 pm

Everyone should take a look at Cole Credit Property Trust (or Cole I) as this was the first (and thankfully much smaller) offering in this series.

Cole I issued a letter on Feb 10 telling shareholders that the distribution has been cut for 2010 to 5% (on the original $10 purchase price) and the NAV has been cut to $7.65/share. Redemption has been suspended since 2008 and even if reinstated you get your money back at the lesser of your original purchase price; $8.50 or 90% of $7.65 or $6.89.

They just issued another release on April 7 stating that they had refinanced $50m in debt at 7% and at a 60% LTV on about 50% of their portfolio. I don't know what this is going to do to their finances precisely, but it must be a much higher rate than they had originally, hence the "dividend" (60% of dividends have consistently been return of capital) cut.

I have attached the letter below for your reading pleasure. Would anyone care to start a pool on where Cole II's (stated) NAV will be when they have to post one in a few months? I imagine they will get their "independent" valuation agents to give them something in the $8-8.50 range and the legitimate value will be more like $7. Well done, Cole.

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Cole I Letter to Shareholders.pdf
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Re: Cole REIT Has Dividend Problems

Postby REIT Wrecks » Fri Apr 30, 2010 12:15 pm

So let me get this straight:

If Cole allowed shareholders to redeem their CCPT I shares under the redemption program, they say they would give you 90% of NAV, which means $6.89. But you can't get $6.89, because they won't redeem your shares. The whole thing is an absolute joke!

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Re: Cole REIT Has Dividend Problems

Postby moneybags » Sat Apr 09, 2011 3:04 pm

Worse than a joke, this coming from somebody who lost about 7500 dollars from that piece of trash...

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Re: Cole REIT Has Dividend Problems

Postby sammyz » Tue Jul 12, 2011 7:09 pm

It sounds like you guys have some axe to grind. Please tell me what investment came through the crash in better shape than Cole. I own this investment in my IRA actually. I saw managed accounts decimated from all the major Wall Street Firms. Trillions have been lost since 2008. Working for a CPA firm I can tell you commercial real estate on its own has been clobered.We get to see investments from the very wealthiest investors and I can report that few faired better than Cole investors.I saw other REIT's completly go away.Are you you kidding me? The Circuit City example sited is pretty telling.Cole sold all but 1 of those properties before Circiut City ever moved out.Would you rather own the bonds ? The stocks ? Really.....you guys are looking through a lens that is shaded obviously for a purpose of your own design. We have many clients that lost millions in a variety of WAll Street investments that only wish they were in Cole........The credit markets dissapeared and the Cole long term lease model held up from all that I can see.Quibble over 7% or 6% and have a legitamate disscusion on the internals.....but the reality of the damage out there ......well......no one here has convinced me of anything better.......you are major league whiners. I would LOVE to see your personal portfolios...!! I have a feeling that is where all the anger is coming from....... Are you all in foreclosure ? Please share your investment philosophy.......we are dying to hear.........

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Re: Cole REIT Has Dividend Problems

Postby sammyz » Tue Jul 12, 2011 7:33 pm

In 2009 when even the mighty Goldman Sachs couldnot raise money somehow Cole managed to raise $2 billion dollars in a matter of a few months!This in the worst environment in recent memory. That can only happen with a solid investor base. And no I do not work for Cole. I guess I am just not as smart as you guys......

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Re: Cole REIT Has Dividend Problems

Postby sammyz » Wed Jul 13, 2011 6:02 am

I notice you use the the Morgan Stanlely Index as a benchmark. What you did not mention was Morgan Stanley's traded REIT lost 85% of it's value in May of 2009. Morgan's Ceo announced this in May of 2009 and it was headline news on CNBC as Morgan Stanley's future was in doubt at that time after the demise of Bear Stearns and Leman. You do not mention that the credit markets totaly froze and commercial property across the country and across the globe lost 30 to 40% of it's value and that any over leveraged property with a loan due was in immediate trouble. Multi tennant office watched tenants flee the exit's in numbers not seen since the Great Depression. From what I see the Cole single tenant model and low leverage and long corporate lease structure saved them and their investors quite well. I say again .....most investments failed when the market collapased.I do not see the arguement here other than a few points about internal distribution.At one point you are saying Cole was to generous on their distribution ! After all this chatter they still have a hard asset that produces income and they can wait out the economy and sell when they choose ! And those type of assets are now getting multiple bids as the credit markets thaw....they and their investors appear to be the great survivors ! The only other investment I see that did as well is a few bond funds !!

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Re: Cole REIT Has Dividend Problems

Postby losemoneynow » Wed Jul 13, 2011 8:21 am

Sammy,

Before you take victory laps on your Cole investment you should note that Cole has yet to take a REIT full cycle. REIT 1 and REIT 2 are seriously under water and losing value every day. That's what happens as years burn off of net leases; the income streams become less valuable and the value takes a hit. REIT 1 is a disaster from a valuation standpoint and REIT 2 trades regularly in the secondary market at $6.75 per share. Worse yet, REIT 3, which is still raising money at $10 per share trades in the secondary market at $7.75 per share. Cole was lax in exploring exit possibilities for REITS 1 and 2 and now faces a menu of limited choices.

Cole has announced they are exploring exit options for REIT 2. Those options are next to nil given that the average remaining lease term will be less than 10 years by the time something gets done. The assets are in tertiary markets and the clock is ticking on lease term (as mentioned) and debt maturities on the portfolio. Who will step up and pay par or even a premium for these cash flows? This REIT has been subsidizing its reduced dividend with DRIP and Line of Credit, further eroding capital. Net leases pay cash flow but the other side of the coin that no one seems to talk about is that those cash flow streams decline in value in the market place as years burn off of those leases. After you factor in the vaporization of 13% of your initial investment plus the value loss endemic to aging net-leased portfolios the end result is going to be unattractive at best.

My guess is that Cole will quietly explore and perhaps consummate a transaction where REIT 3 buys REIT 1 and hopes no one will notice. Since REIT 1 only has $200 million in assets they might get away with it. Investors in REIT 1 will suffer losses but the limited size of the fund might just limit the negative publicity of a related party transaction. Then they have to deal with REIT 2 which, as we mentioned, has lost serious value as most of those assets were bought before the crash and remain seriously impaired in terms of where markets will ultimately value them.

The proof is always in the pudding. What total return will Cole generate from these programs? With distributions and share prices already cut on depreciating assets (thats what net leased assets truly are) it seems to me the final chapter has already been written. Best to wait and see the final results. As an aside, if Chris Cole had any conviction that these were going to be good investments why did he only invest the bare minimum of $200,000 in each of these REITs? He has investors that put in far more than he did...was that really a smart thing to do?

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Re: Cole REIT Has Dividend Problems

Postby cloudybright » Fri Jul 15, 2011 10:33 am

Thanks for that perspective sammyz.

When we planned with our adviser, bucket #3 was the long-term highest risk bucket.
In that we put our reits.
Considering the recent financial decimation and the great fear in the marketplace, Cole is still alive.
Real estate markets move in 15-year cycles in my personal observation.
And NOW is the time to be buying, if you can, while blood is in the streets.

Its not risk free, by any means.
If one is looking for "risk free" then an annuity might better serve them.

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Re: Cole REIT Has Dividend Problems

Postby bobsmith » Sat Jul 16, 2011 7:13 am

Cloudy,

It sounds like if you put this investment into "bucket #3" that you are working with an adviser using Ray Lucia's "Buckets of Money" strategy? I am going to write a bunch more about this guy on another thread in this forum, but it would be interesting to hear from you if your adviser was up-front with how much money they were making to fill this bucket for you and whether they purported to be your "fiduciary" at any time in the process. Are they a First Allied broker?

These non-traded REITs are certainly not risk-free assets. But I would characterize them as "return-free" as well. Essentially what the sponsors have done is to create a structure that provides a very high probability of earning a very low return (lower than what you can get from Treasuries). They get to use your money to generate fees for themselves. I imagine that most people will pretty much get their money back from these deals in the end, maybe with a small gain (though much lower than what a comparable investment in publicly-traded REITs would generate if made at the same time), or maybe a small loss. But you are risking a large potential loss for the possibility of a small gain. The chances that investors will make double-digit total returns in any of the big REITs out there right now are very low given where cap rates are and the general state of the industry.

Below is a very simple spreadsheet (attached below - sorry - I don't know how to embed it) that shows your total return on the first two Cole REITs through the end of 2010 would be 3.1% down to -1% per year depending on what you assume the current value to be. And this is a bit optimistic because you have no or very limited options to get out of these deals right now anyway.

Cole REITs.xls
(22.5 KiB) Downloaded 668 times


I could have chosen any number of REITs out there that raised funds around the same time (or later) and you would see the same pattern (I am working on a larger spreadsheet that does this). These structures provide investors very low total returns due primarily to the extortionate fees paid at inception. I imagine that the the "base case" returns that investors are likely to see are never disclosed to them. If they were, people would question why they don't just buy Treasuries (or other instruments), which would have returned over 4% per year in yield if purchased in 2005-06. If you buy a 10-year Treasury with a 4.25% yield then you know you will get a return of 4.25% per year if you hold for 10 years. This is your baseline for a liquid, risk-free investment. Non-traded REITs should have expected returns well above Treasuries when you invest due to the risk, liquidity, etc. But, due to the fees alone, they cannot without some heroic assumptions about the ability of the sponsor to buy great properties as well as the direction of the RE market.

It is not a problem for advisers to put clients into investments that later turn out to have been a bad deal - that is life and nobody has a crystal ball. But it is a problem for advisers to put clients into investments that the adviser knows, or should know, is likely to produce sub-par returns simply because the investment pays a super-normal sales commission.

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