Cole REIT III "Wholly Inappropriate" Says Advisor

[REIT Wrecks]

Homer said it takes two people to lie: one to do the lying, and one to do the listening. P-Solve, a pension fund advisor that provides financial advice to over 150 institutional clients with over $30 billion in assets, isn't listening. In fact, rather than be associated - even indirectly - with the town of West Warwick's decision to invest in Cole REIT III, P-Solve chose to resign as the town's advisor.

Rarely do you see language like this in an investment recommendation. Calling Cole REIT III fees "astronomical and extremely inappropriate," and noting that Cole REIT III suffers from misleading accounting, conflicts of interest and illiquidity, P-Solve said not only that they could not recommend Cole, but that they would "implore [the town of West Warwick] not to make this investment." P-Solve, citing hundreds of years of collective investing experience, said they had "rarely, if ever, seen an investment more inappropriate than this one." But you don't have to take my word for it. Their memo is here, and you can read it for yourself:

Cole REIT III Has "Astronomical" Fees

October_P-Solve_Memo.jpg (268.27 KiB) Viewed 25322 times

Incredulously, despite P-Solve's strong opposition, the West Warwick Pension Board voted unanimously to approve the investment. After the vote, the Providence Journal did an absolutely wonderful job of picking off some voluptuous quotes from the board members, including some choice indiscretions from the board's chairman, a fellow named Terry Rouselle, who is perhaps best known for running the local liquor store. [url=http://www.projo.com/business/content/WEST_WARWICK_PENSION_INVESTMENT_04-25-10_BKI7_v53.360ab1e.html]According to the Journal[/url], Rouselle said that Cole guaranteed the town a 7% return.

It was a 7-percent guaranteed return,” Rousselle said. “They promised us 7 percent."

It's certainly possible that Cole representatives made such claims in person, but it's more likely that Rouselle has simply spent too much time around the hooch, and not enough time scrutinizing the fine print. This is what Cole says in its most recent 10-K:

We may be unable to pay or maintain cash distributions...Actual cash available for distributions may vary substantially from estimates."

Frankly, I find it more than curious that a board could vote unanimously in favor of an investment like this, given the opposition of their advisor and their own ignorance of the facts. As P-Solve's letter points out, the board was "introduced" to Cole REIT III by Jeffrey E. Bogosian, who is a local stock broker friendly with the board. Bogosian, of course, stood to earn a substantial commission if the board made the investment. In fact, according to P-Solve, the total upfront commissions and the fees were so excessive they would be sufficient to pay all of the town's advisors for an entire year.

But it gets even worse if you're a retired firefighter, cop or sanitation worker in West Warwick. Not only was Rouselle completely uninformed, it's quite possible that his ignorance stems from basic illiteracy. What else could explain this dandy statement from the chairman?

We get 7 percent monthly. I don’t know what their management fees are. I don’t really care,”

If Rouselle doesn't know, it's abundantly clear that he should. I attach "Exhibit 1" from P-Solve's July memo to the board, and it provides explicit detail on Cole's management fees:

Can Rouselle Read??

Exhibit-1.gif (63.76 KiB) Viewed 25322 times

It's too early to tell whether Cole REIT III will be a decent investment, but it's clearly not suitable for the town of West Warwick, whose managers are not even capable of reading a memo from their own independent advisor. Talk about low hanging fruit. However, at this point, Cole is doing just as expected: paying dividends using offering proceeds and borrowings, while paying themselves "astronomical and extremely inappropriate fees." In fact, in 2009, while it got busy paying dividends using cash from new investors and loan proceeds - not earnings - Cole paid itself $14.1 million in acquisition fees and $1.3 million in asset management fees. How can this even be legal, nevermind sensible?

According to Cole, the Company funded its $21.8 million in 2009 dividends using Adjusted Funds From Operations ("AFFO") of $18.6 million and by borrowing $3.2 million. Even by this generous measure, Cole paid a dividend that was almost 20% more than they earned. However, Cole's reported AFFO also appears to include the aforementioned $14.1 million in acquisition fees. If so, backing those fees out would result in AFFO of only $4.5 million and a 2009 dividend that was $17.1 million in the hole. In fact, according to the Cole REIT III 10-K, 45% of the dividend was funded simply by returning shareholders' own money.

This is not the kind of "investment" that the seniors of West Warwick need and deserve. Furthermore, it's clear that the current West Warwick Pension Board is not competent to run an ice cream truck, nevermind a $30 million retirement fund. Before they can do any further damage and expose their members to even more potential harm, they should be removed, and the new board should insist that Cole return the town's money immediately, in full and without penalty.

Rouselle's reaction to all this? “I don’t know how that memo was leaked. It should have stayed within the board.”

Below is P-Solve's resignation letter. To print, email or share this post, click the "+share" button on the bottom right.

P-Solve to West Warwick: Replace the Board Now

P-Solve Resignation Letter.jpg (153.75 KiB) Viewed 25322 times

[Update: The town of West Warwick now has its money back. For more on that, read [url=http://www.reitwrecks.com/forum/viewtopic.php?f=2&t=23]Cole REIT Redemption Flip Flop: Are Some Shareholders Special?[/url]


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[url=http://www.reitwrecks.com/forum/viewtopic.php?f=2&t=23]Cole REIT Redemption Flip Flop: Are Some Investors Special?[/url]

[url=http://www.reitwrecks.com/forum/viewtopic.php?f=2&t=20]Cole REIT Has Dividend Problems[/url]

[url=http://reitwrecks.com/2009/05/non-traded-reits-are-designed-to-be.html]Non-Traded REITs Are Designed to be Sold, Not Bought[/url]

[bobsmith]

This is a pretty amazing story. I can't believe that people are actually this arrogant and corrupt to think that they would get away with this.

Cole should be concerned that these kinds of stories are getting out there and will probably be working on some damage control now. I think their first order of business would be to send back this investment and recoup their commission money from Bogosian. The board that made this investment will surely be removed and the new board will ask for it back anyway.

When are we going to see some bigger stories come out on this whole sector? Non-traded REITs may not ultimately lose people as much money as Madoff, but it may be close.

[ray of sunshine]

This really is incredible. It looks like the board was on the take, and on top of being arrogant and corrupt, just plain stupid. What I don't get is the point REIT Wrecks brought up in the first post - - how are these things legal in the first place?? If non-traded REITs are legal, for whatever reason, then they are basically just a license to steal. Who buys these things???

[Hollywood]

I have invested in these products for some time now and I would like to refute some of the claims made by P-Solve.

1. The fees are NOT as excessive as P-Solve points out. Fees are "burned off" over time and Non-Traded REITs are designed to be held for 7 years (or more). Besides, their dividend (7%) is net of fees.
2. The statement, "Cole can make lots of money whether or not the investors do well". Are these people really in the financial services business? Seriously? Do mutual funds make money if their funds go down? YES! Do money managers make money if their accounts go down? YES! How about bond funds? That would be a YES too!!
3. Diversification is lower than in a stock or bond fund? Guys, do your homework. Cole's previous REIT has 704 properties and this one is larger. Does anybody know of a stock or bond fund with more than 704 holdings??

For those of you who like the stock market so much. Here is food for thought. When Circuit City went bankrupt, who made out better. Was it the stockholders, bondholders or the landlord??? The stockholders got zilch. The bondholders got pennies on the dollar. The landlord got their properties back and has the opportunity to find a new tenant.

[WTF?]

Hollywood, your post is comedic. The commissions and fees ARE excessive, and now I can see why brokers and sponsors like these things so much. Brokers get a commission that would be almost impossible to earn anywhere else, while sponsors get rich just from the act of buying property - no matter what the price. Between them, they rake 15% in commissions and fees right off the top, and with a share price that never changes, not to mention a dividend that's fictitious, it's almost impossible for the poor investors to know anything is wrong until it's too late (see last paragraph).

Commercial real estate is commercial real estate. It's purchased by wealthy individuals, or groups of them, and numerous institutional investors - including REITs. All of these investors fish in the same pond for basically the same properties. There is no secret formula. All of them are smart, and given similar skill levels, their returns will also be pretty similar - except that fees will vary. So how could higher fees possibly improve results? And 15% is not just high, it's outrageous.

Also, you forgot a few things on the Circuit City bankruptcy. In addition to getting a vacant shell of a building back, landlords get another bonus: they get to pay for utilities, maintenance, insurance, security, property taxes and the mortgage. These bills do not go away. And if the landlord doesn't pay any of these bills, for any reason, the lender will declare a default and foreclose. Poof! This is happening to landlords all over the country, especially those that overpaid for retail assets, and it is wiping out their equity just like any stock or bondholder.

[REIT Wrecks]

The fees are NOT as excessive as P-Solve points out. Fees are "burned off" over time

Why wait? Just do this:

burn_your_money_now.jpg (3.73 KiB) Viewed 24726 times

It would be quicker and easier.

[bobsmith]

Hollywood,

Would you care to expand on this thought further please:

1. The fees are NOT as excessive as P-Solve points out. Fees are "burned off" over time and Non-Traded REITs are designed to be held for 7 years (or more). Besides, their dividend (7%) is net of fees.

How are fees "burned off"? Aren't they just "burned up"? If I pay a broker 7% up-front then I have 7% less of my money being used productively. Period. There is no such thing as a "burn off" period. The fees don't come out of Cole's cut, they come straight from the investor.

True, the 7% dividend is net of fees. But what would the dividend be if 13% didn't come off the top plus several % on an ongoing basis? What might other real estate investments buying similar things pay? But the real problem is that the 7% dividend cannot be supported unless the price of the underlying real estate rises significantly (which would theoretically allow disposal gains to fund promised distributions). If prices simply stay the same, or fall, then the whole thing falls over. It also falls over, and this is true even if prices rise modestly, if financing terms change and you have to replace the ridiculous interest-only loans common in 2004-2007 with traditional amortizing loans. It is awfully difficult to have an 8.5% gross rental yield, pay exorbitant fees and operating expenses, pay 6.5% interest and repay principal while supporting a 7% dividend. Said another way, if you consistently pay out 100% of FFO in dividends then absolutely nothing can go wrong or you fall over. Cole I paid out 100% of FFO in dividends and then had to re-finance a bunch of the portfolio. Ooops - now it has a 5% dividend and an (inflated) $7.65 NAV. The properties are still 100% leased up and nothing in the underlying portfolio has really changed. But yet the "stable" 7% dividend and share price had to be cut.

[sourgrapes]

The fees are NOT as excessive as P-Solve points out. Fees are "burned off" over time

Why wait? Just do this:

burn_your_money_now.jpg

It would be quicker and easier.

John,

When you were buying properties for Cole you weren't complaining about the fees. You have a lot of time on your hands.

[REIT Wrecks]

Ho-hum. Yawn. Let me guess, you're a probie at Cole. Which department?

[CAPT_DOMM]

Is this still wholly inappropriate? Current share price is 12.31.

This forum is totally dead except for the Apple REIT forum.

I guess the real estate rally may have had something to do with it.

Anyone out there buy a BDC? I am specifically looking at the Franklin Square Energy and Power. I might add some to my portfolio...

Any help would be appreciated if anyone is around here still...