American Realty Capital Trust: FFOol Me Once...

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American Realty Capital Trust: FFOol Me Once...

Post by REIT Wrecks » Fri Jun 17, 2011 9:00 am

Remember Uri Geller? He was a TV psychic who claimed to bend spoons with the power of his mind. His big secret? Geller refused to bend spoons to which he had no prior access. It was eventually concluded Geller was pre-bending the spoons and, through diversions and distractions, made a lot of really smart people believe the unbelievable. So, what does Geller have to do with American Realty Capital? For a start, American Realty Capital management appears to share Geller's affection for diversions and distractions, if not his talent for creating illusions and suspending disbelief.

Like Geller, American Realty Capital is nothing if not a marketing machine; the Company employs a huge fleet of wholesalers, and it sponsors a whole raft of non-traded REITs. Press releases are one of American Realty Capital's favorite marketing tools, and one of the latest missives was launched on April 25th when American Realty Capital Trust Inc ("ARCT") announced a new equity-based compensation arrangement for its external advisor (ARCT is American Realty Capital's flagship REIT, and American Realty Capital Advisors is ARCT's external advisor). This press release was vintage American Realty Capital: it declared that American Realty Capital "continued to find new ways to put shareholders first." And just like Uri Geller, who said he could bend spoons with his brain, American Realty Capital also boasted of being a "thought leader" in the industry.

Taken separately, that cheerful April 25th press release and [url=http://www.reitwrecks.com/forum/docs/American-Realty-Capital-June-7-8K.pdf]last week's austere 8K filing[/url] don't appear to be related in any meaningful way. However, the two are actually very much connected, and together they add up to one very sobering question: where exactly did that $6.4 million in prepaid advisory fees go?

In fact, last week's 8k filing, barely two sentences long, quietly confirmed what ARCT obviously chose not to disclose in one of its trademark press releases: American Realty Capital had violated its advisory agreement with ARCT. It also suggested that ARCT's April 25th announcement was really just a crafty way to circumvent the Company's much publicized asset management fee "waiver", and it confirmed suspicions that the entire sequence of events was related to an elaborate accounting scheme designed solely to inflate ARCT's dividend coverage. Thought leaders indeed!

Not only was the pre-payment of the advisory fee in violation of ARCTs advisory agreement, it also looks like the prepayment would constitute an interest-free loan to American Realty Capital, and if that's true, it would be a clear violation of [url=http://www.reitwrecks.com/forum/docs/NASAA-REIT-Guidelines.pdf]Section V.C.1 of NASAA's REIT Guidelines ("CONFLICTS OF INTEREST AND INVESTMENT RESTRICTIONS")[/url]. Hence American Realty Capital's quiet June 7th reversal.

The whole saga turns on American Realty Capital's much-publicized asset management fee waiver, which was allegedly implemented to "put shareholders first". Now, that "waiver" looks a lot less like a waiver and much more like a regular old IOU. The unvarnished truth is that American Realty Capital's new equity compensation plan allows them to collect all of their asset management fees in the form of stock, and shareholders will still pay the bill either way. Thus, the fee waiver is not a true fee waiver at all. If you have any doubts about this, just take a quick read of that [url=http://www.reitwrecks.com/forum/docs/American-Realty-Capital-Trust-April-25th-press-release.pdf]April 25th press release[/url] which announced the new "equity based compensation plan" for the advisor.

And what about that 100% dividend coverage that ARCT celebrates so often? Well, it looks like American Realty Capital is bending that spoon too. ARCT’s first quarter Form 10Q reflects total asset management fees of $2.464 million – but only $600,000 of that was charged through to its income statement and, thus, the only $600,000 was reflected in Company's reported Modified Funds From Operations ("MFFO"). It's not at all clear where the remaining $1.864 million went, or where it is now, because all of ARCT's asset management fees were prepaid to American Realty Capital back in January. What is clear is that if one were to add back to MFFO the $1.864 in fees that were "waived", ARCTs perfect 100% dividend coverage would drop to 83%.

With respect to the prepayments of the asset management fee, ARCT reports having prepaid a total of approximately $6.4 million in asset management fees to American Realty Capital in 2010 and Q1 2011. However, to the extent those fees were truly waived, shouldn't those prepayments be remitted immediately back to the REIT and its shareholder/owners? Furthermore, if these fee prepayments didn't go back to the REIT, where exactly is that money now??

The balance sheet could provide a clue. ARCT's March 31st balance sheet reflects a “Prepaid fees and other assets” balance of $22.363 million. That seems like a big number for which there is no substantive detail in the financial statements or the notes. So the question remains: what portion of the prepaid fees has yet to be reimbursed from the advisor back to the REIT? We all know from the ARCT press releases that those fees were waived and that shareholders are always put first, so where's the beef?

At this moment, ARCT's SEC filings indicate only that the advisor collected the cash, ARCT booked the cash advanced into another asset account (Prepaid fees) and then expensed only $600k of the $2.464 million in fees earned by the advisor, thus overstating both GAAP Net Income and MFFO. By overstating MFFO, ARCT's "perfect" dividend coverage also appears to be a bent spoon, and even worse, it looks like there are several spoons missing from ARCT's silver chest.

Sadly, it seems that ARCT's "thought leading" fee waiver is not really what American Realty Capital says it is. In fact, at this moment, it all appears to be connected to a series of elaborate accounting entries whose sole purpose is to report artificially higher MFFO, with the fee "waiver" collected on the back-end. Higher MFFO means better dividend coverage, boys and girls, and that's what this game is all about. American Realty Capital also needs to explain in detail the "prepaid fees and other assets" balance sheet entries, one by one. ARCT could wind up being a great investment for all I know, but right now, I'm not sure what I know. FFOol me once, shame on you, FFOol me twice, shame on me.

Related Posts:
[url=http://www.reitwrecks.com/forum/viewtopic.php?f=24&t=135]American Realty Uses ARCT Shareholder Cash to Subsidize Launch of New REIT[/url]
[url=http://www.reitwrecks.com/forum/viewtopic.php?f=24&t=141]I Run a Non-Traded REIT, and I am a Rock Star[/url]

WoodrowWilson1
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Re: American Realty Capital Trust: FFOol Me Once...

Post by WoodrowWilson1 » Fri Jun 17, 2011 3:57 pm

Your post of this morning is yet another attempt to string together unrelated bits and pieces of information. Once again, you have failed to recognize, or perhaps you simply don’t understand, the information about which you are purporting to be an expert.

Facts are facts, so that’s all I want to discuss here. But I don’t want to discuss the fact that American Realty Capital’s competitors are seeking any way they can disparage ARCT and that you are permitting them to use your blog as a marketing tool for negative selling of ARCT. Nope, all I want to talk about are the facts as published in multiple third party sources and as filed with the SEC and as recognized by Moody’s and Standard & Poor’s in their ratings of Ba3 and B+, respectively. So here goes:

First of all, do you know what the NASAA guidelines state or are you just copying and pasting from a memo, as provided to you by one of their competitors? If you did understand these guidelines, or bothered to take a peek at them before you posted on your blog, you’d see that there is no commentary on the timing of the payment of asset management fees, be they prepaid or otherwise. In fact, all the guidelines say is that the advisor is entitled to an asset management fee.

(Point of order, you have a bad link. Your link to the guideline isn’t working. It’s actually directing to ARCT’s 8-K. Why is that?)
Secondly, I’ve spoken with a number of CPAs who concur that prepaid expenses do not have a P&L statement or FFO/MFFO impact at all and I am baffled by your conclusion that this somehow impacts distribution coverage/MFFO. From what I can tell, you are not a CPA and are therefore not qualified to make these types of assertions alone. Are you getting your information from someone else? Please cite your sources.

ARCT did actually file a [url=http://www.sec.gov/Archives/edgar/data/1410997/000114420409048132/v160095_posam.htm]supplement with the SEC on 9/11/2009[/url] that clearly discloses the company’s pre-paid asset management fees up to two quarters in advance. See below for some detail on asset management fees paid in the [url=http://www.sec.gov/Archives/edgar/data/1410997/000114420409043783/v157180_10q.htm]10-Q report for the quater ended June 30, 2009:[/url]

The Company pays the Advisor an annualized asset management fee of up to 1.0% based on the aggregate contract purchase price of acquired real estate investments. The asset management fee is payable quarterly in advance on the first day of the month following the end of each calendar quarter end. Such advance fees cannot exceed estimated asset management fees for the subsequent two calendar quarterly periods. The Company incurred asset management fees of $28,000 during the three months ended March 31, 2009, which were subsequently refunded by the Advisor to improve the Company’s working capital position. The Advisor was entitled to asset management fees of $771,143 and $214,102 during the six months ended June 30, 2009 and 2008, respectively. These fees have been waived (not deferred) by the Advisor, contributing to the Company funding its distributions to shareholders entirely from cash generated from funds from operations. As of June 30, 2009, the Company paid the Advisor $950,000 of asset management fees for the subsequent two quarterly periods. Such amount is included within prepaid expenses on the accompanying balance sheet.

Also, this is clearly not a loan, otherwise the company’s auditors (please refer to the audited 10-K for verification) would require this to be reflected as a loan due from the advisor on the balance sheet. And this is not the case. Why do you describe it as a loan? Please cite your facts regarding this point.

Restricted Stock
As to your assertion that they are collecting previously waived asset management fees, please read the [url=http://www.sec.gov/Archives/edgar/data/1410997/000114420411023976/v219749_8-k.htm]4/25/2011 8-K again.[/url] I’ve read the 8-k’s, I’ve read all the relevant releases, including their 10-K financials, and nowhere does it say that they are recapturing waived fees in the form of restricted stock. That seems completely baseless and I am at a complete loss. Their auditors would make them disclose this in the compensation tables if this were true.

Your comment on missing silverware is incorrect. Clearly, you are attempting to draw a conclusion from unrelated bits of information, for what purpose I don’t know. From what I can tell, this company has acquired great assets, opened their books in order to receive a credit rating from Moody’s and S&P, is closing on time with no follow on, is performing in accordance with their prospectus, and has engaged Goldman Sachs to advise on their strategic options. The proof will be in the execution of the exit. The company will pay no internalization fee, will be compensated only after investors receive a cumulative return of 106%, and, in doing so, will make the non-traded REIT industry better. Maybe I’m missing something, but I can’t see the harm in what they’re doing. It’s not perfect, but it is certainly many steps in the right direction for this industry.

Even if all the unrelated threads you brought together were true I fail to see the significance because the impact to shareholders is de minimis. From my back of the napkin calculation, even if everything you are dreaming is even close to true, I would suspect that their coverage ratio is still one of the top in the industry. Without ARCT you wouldn’t even be having an MFFO coverage conversation. Waiving millions of dollars’ worth of fees is not, however, insignificant to me or other shareholders because they are the only ones doing it. No matter how you spin it, it is a positive to investors. Your whole post is pointless because [url=http://www.sec.gov/Archives/edgar/data/1410997/000114420411034307/v225182_8k.htm]the attached 8-K[/url] eliminates the pre-paid nature of asset management fees that your post addresses.

I’m in the industry; I’ve taken the time to site my references. Please do your readers a courtesy and do the same. Who is really bending spoons here? To me, it seems as if this blog is not only bending spoons, but forks, knives and the kitchen sink.

"If you want to make enemies, try to change something." -- Woodrow Wilson

WoodrowWilson1
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Joined: Fri Jun 17, 2011 3:24 pm

Re: American Realty Capital Trust: FFOol Me Once...

Post by WoodrowWilson1 » Fri Jun 17, 2011 4:16 pm

I wanted to clarify my previous post and point out exactly where ARCT made the change regarding asset management fees. If you look at page 26 of [url=http://www.sec.gov/Archives/edgar/data/1410997/000114420409048132/v160095_posam.htm]the supplement filed on 9/11/2009[/url] you'll see that ARCT clearly discloses the company’s pre-paid asset management fees up to two quarters in advance. This was filed nearly two years ago.

"The following language replaces the information concerning payment of the Asset Management Fee on pages 7 and 55.

We will pay to American Realty Capital Advisors, LLC a yearly fee equal to 1% of the contract purchase price of all the properties payable semiannually based on assets held by us on the measurement date, adjusted for appropriate closing dates for individual property acquisitions."

Shareholder71
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Re: American Realty Capital Trust: FFOol Me Once...

Post by Shareholder71 » Fri Jun 17, 2011 4:40 pm

If I'm reading this correctly as an advisor, it appears as though ARCT was fronting themselves cash that they had not yet earned then deferring or waving a small portion of it. The purpose of which was to help their coverage ratios look better while also getting credit for being altruistic and good to the investors. So ARCT got the cash they wanted and promoted a better image of rightiousness while actually not living up to either. Have we been hoodwinked? Shall I gladly pay you Tuesday for a hamburger today?

However, it also appears as though someone figured this out at RW and is calling them out on it. Judging by the vinegar response above my guess is that the truth is hitting a little too close to home.

So in many ways I'm seeing the early days of the Anthony Weiner scandle brewing, i.e. denial may cause more problems than honesty.

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Re: American Realty Capital Trust: FFOol Me Once...

Post by REIT Wrecks » Sat Jun 18, 2011 10:31 am

Woodrow,

I'm sorry, but your response is a parody of itself. I'm not sure what outing me has to do with any of the accounting questions at ARCT, but have at it.

As for the point of order, I check the links after the post is published -- for obvious reasons -- and you are indeed correct: not all the links were working. I suppose I should be flattered that you monitor the blog so closely (or maybe even a little concerned), but those bad links were updated shortly after the post was published and long before you posted your curious reply. As a matter of fact, the link to the 8K wasn't working at all. It was easy to fix though, and I thought it was deliciously ironic that the link was broken simply because it was missing the word "Trust".

So getting back to the substance of the original post, as opposed to diversions and distractions, I think ARCT needs to do a better job on this. Shareholder71's Weiner analogy is completely appropriate. Did somebody hack the financials? What's with that prepaid account balance on the balance sheet, and where is the actual cash? Why is there not more comprehensive disclosure in the notes? If ARCT is really putting shareholders first, and if transparency and progressiveness are truly ARCT's hallmarks, why not aspire to produce an income statement and balance sheet that answer more questions than they produce? And is it really ARCT's position that fee prepayments are allowed simply because the NASAA REIT guidelines fail to address that concept specifically? That argument seems more cute than progressive, never mind the fact that it ignores an obvious conflict with the prohibition on loans.

If ARCT's asset management fees have been permanently waived, then I think American Realty Capital needs to state categorically that the fee waiver is permanent, as in forever and ever and ever, and that the equity compensation plan will not later be used to make a land grab after ARCT's sales quotas have been met.

Furthermore, if that fee waiver is indeed permanent, then the cash associated with prepaid fees that were subsequently waived should be converted from a balance sheet entry into real Benjamins, thank you very much (or perhaps somebody could instead point me to the section in the ARCT prospectus that deals with the disclosure of external advisor credit risk).

American Realty Capital's talk of transparency and proper alignment of shareholder/sponsor interests quickly caught my attention, but I wrote this post because many of American Realty Capital's actions have been inconsistent with that talk, including a pay for performance plan [url=http://www.reitwrecks.com/forum/viewtopic.php?f=24&t=141]that makes a mockery of the word performance[/url] (I had some fun with that one!), and using ARCT shareholder cash to enter into an off-market jv deal with an affiliate [url=http://www.reitwrecks.com/forum/viewtopic.php?f=24&t=135]on terms that no other joint venture equity provider would even consider[/url]. Should we also talk [url=http://www.reitwrecks.com/forum/viewtopic.php?f=10&t=30]mega bait and switch at HTA?[/url]

This topic is obviously controversial, and the accounting questions are potentially significant, so I'm not surprised that the original post provoked a passionate reply from someone at American Realty Capital. Sadly, it was pretty ordinary, in my opinion.

For those of you who aren't familiar, Woodrow Wilson was a leader of the Progressive Movement. He implemented a number of major reforms, including the anti-trust act, led the United States through World War I, helped negotiate the Treaty of Versailles and tirelessly promoted the League of Nations. As admirable as all that was, Teddy Roosevelt was also a leader of the Progressive Movement, and he was arguably a better President. Famously, as the founder of the independent "Bull Moose" party, he didn't tolerate bullsh*t well either. Perhaps the next post from American Realty Capital will be under a pseudonym derived from his name, not Wilson's:
Teddy Roosevelt wrote:To announce that there must be no criticism of the President, or that we are to stand by the President, right or wrong, is not only unpatriotic and servile, but is morally treasonable to the American public. Nothing but the truth should be spoken about him or any one else. But it is even more important to tell the truth, pleasant or unpleasant, about him than about any one else."
Honest mistakes are gratefully tolerated, and God knows I've sure made plenty of them. It's obfuscation and denial that don't wear well.

Follow Up Post:
[url=http://www.reitwrecks.com/forum/viewtopic.php?f=24&t=226]FactRight LLC - Doubters Not Allowed![/url]

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