Monday, January 08, 2018

Merger Misfire

It has been almost a year since the Colony Capital, NorthStar Realty Finance, and NorthStar Asset Management's tri-party merger closed and began trading on the New York Stock Exchange under the symbol CLNS.  In a year that saw the S&P 500 rise 19%, CLNS fell 20%, nearly an inverse perforamnce to the broader market.  As an encore to 2017, CLNS is off 4% so far in 2018.  I don't think these results were what CLNS planned from the tri-party merger.  But given how inert the CLNS retail product side has been, I am not sure what results could have been expected.  Advisors and investors have shunned CLNS's lackluster, non-core, non-traded REIT (good luck finding any reference to CLNS's 27% ownership in RXR anywhere on CLNS's website) and its closed-end fund that is similar in objective to NorthStar's two distribution overpaying income REITs. 

The chronic distribution over payments at NorthStar's three income non-traded REITs are serious.  In an under reported December 2017 move, NorthStar Healthcare Income REIT cut its distribution in half, abruptly facing the reality of the income its investments were generating.  I am watching the merger of NorthStar Income I and II with certain CLNS assets to not only see what the new market value is compared to the original purchase price for each REIT, but what the new distribution is compared to what the two REITs are paying investors.  While their distribution over payment is not as acute as Healthcare's, Income I and II still pay out more in distributions than they generate in cash. 

The Colony and NorthStar executives had six months before the merger closed to devise new products and strategies that leveraged the strength of the new organization.  No products were announced at the time of the merger and nothing has been announced since the merger closed a year ago.  CLNS is selling the products NorthStar already had available or in registration.  Most NorthStar executives are now gone from CLNS, or will be soon.  It is hard not to think this executive exit was in the works all along.  The lack of initiative, innovation, or impetus has made CLNS and its retail products not only unattractive, but worse, irrelevant.

Tuesday, January 02, 2018

Looking Critical

Carter Validus Mission Critical REIT announced a new net asset value late on Friday, the last day of a holiday week, right before another holiday weekend.  Mission Critical's timing makes sense when you unpack the filing.  On the surface it's bad:  the REIT's net asset value dropped 7.6% from $10.02 per share to $9.26 per share, based on September 30, 2016, and September 30, 2017, valuation dates.  The news does not get better.  The REIT's real estate valuations, which were down 4.6% year-over-year, included the sales price valuation of the REIT's fifteen data centers.  The sale of the fifteen data centers closed at the end of December 2017 and represented a gain over their book value of $239 million.

I am not optimistic about the REIT's remaining properties if the REIT's total valuation is down 4.6%, but includes the valuation of the fifteen properties sold at 29% gain to book value.  The fifteen property sale is no trifle, they sold for $1.065 billion and netted $768.5 million to the REIT, which is 45% of the equity the REIT raised from investors.

The REIT's letter to investors describing the lower valuation, blamed the decrease, in part, on three healthcare properties and confusingly "certain lost rental income and reserves and write-offs recorded on tenant related notes receivable from certain healthcare care assets."  The three properties, Walnut Hill Medical Center, Cumberland Surgical Hospital and Miami International Medical Center had a combined purchase price of $160,551,000.

The Friday filing also included this passage related to the recent property sales: "We will evaluate and determine how to best deploy the proceeds from our dispositions, including potentially paying a special distribution to stockholders."  The italicized bold is my emphasis.  I have seen other sponsors make large sales and not distribute the proceeds to investors to avoid acknowledging that the income from the remaining assets is insufficient to cover current distribution rates and are likely of lower quality than those that were sold.  Given Carter Validus Mission Critical's chronic over payment of its distribution, apparent trouble in its remaining healthcare assets, and its inability to have a liquidity event in 2015, I am afraid the REIT will reinvest the $768 million rather than return the capital to investors.  Carter Validus is still raising money in Carter Validus Mission Critical REIT II, and while the thought of recycling a portion of a $768 million capital distribution into REIT II may be tempting, I suspect Carter Validus's fear of stopping REIT II's capital inflow will take precedence if it reckons with REIT I's remaining portfolio.  I think there is a good Carter Validus decides to reinvest the $768 million.

Carter Validus REIT I:  Do the right thing and return the $768 million.

Friday, December 29, 2017

NorthStar Interview

I hope you were not drinking coffee while reading the DIWire's interview with NorthStar Securities' Tim Toole this morning.  You would have laughed it all over your computer or electronic device.  Gosh, what drivel.  Given that NorthStar Securities had only raised about $30 million over the first eleven months of 2017, or that NorthStar's first two REITs are combining with certain assets from Colony NorthStar to form a new REIT, or that yesterday NorthStar Healthcare Income REIT announced its cutting its 6.75% annualized distribution in half to 3.375%, or that NorthStar executives David Hamamoto, Daniel Gilbert, and Brett Klein have all announced they are leaving Colony NorthStar early in 2018, and finally that Colony NorthStar announced earlier in December that it is combining NorthStar Securities with S2K Financial Holdings, one of the few firms that managed to raise less money in 2017 than NorthStar Securities, the Q&A had plenty of important topics for discussion and explanation.

Nope.  None of these major events were addressed in the Q&A.  Instead we learned Tim's work history, his favorite book, his fear of Trump tweets, and that he is an adventurous vacationer.  Let's call this puff piece what it is:  Tim Toole marketing himself to other sponsors now that he has been made redundant with the S2K transaction. 

Wednesday, December 06, 2017

Rotten Wood

I just read this InvestmentNews article on the mess that is Woodbridge Group.  Information on one of this outfit's note programs crossed my desk a year or two ago and was summarily dumped in the trash.  According to the InvesmentNews article, Woodbridge raised more than $1 billion, some of which was in its note programs.  In reading Woodbridge's website it states it has "completed over $1 billion in financial transactions," which could mean anything on a real estate promoter's website, but also means it did not raise $1 billion from investors.  Woodbridge has defaulted on its one-year note so investors are no longer getting interest on their notes and their principal is probably in trouble, too, as it now a general unsecured claim. 

For an added outrage and the real reason I am writing this post, Woodbridge's CEO, Robert Shapiro, resigned last Friday but signed a consulting contract that pays him $175,000 a month.  That is stunning.  I am not sure how a bankruptcy judge can let this stand.  This guy needs his previous salary clawed back.

Memo to all:  I don't know if the Woodbridge programs matched any of following points, but as a rule avoid (where avoid means never, never, never consider) note programs where your proceeds are acting, in effect, as development equity for a sponsor.  Here are just some of the issues you face:
  • Development real estate does not generate cash flow to pay your interest, which is important if you are a note holder dependent upon interest payments; 
  • Your notes are subordinated to all other debt including construction and bridge loans, so if something goes wrong, your notes are likely worthless; 
  • The full value of the property, which is essential to repay your note principal and that may or may not secure your notes, is not realized until the development is complete;
  • You are the last debt to get repaid; and, 
  • You share in none of the economic upside, outside of receiving interest and a return of your principal, if the development is successful.  The sponsor keeps this gain and has used your cheap financing to earn its profit.  You took equity-type risk for debt-like returns.
Second memo to all:  Avoid (see above for definition of avoid) note programs that are unsecured, and really, really avoid unsecured notes that are corporate financing for sponsors.  It is a red flag if an investment fund sponsor also offers investments in itself.  Again, you take all the risk, like Woodbridge note investors, and the sponsor gets all the benefits, and when the sponsor loses your money, its former CEO still gets to make $175,000 per month while you get nothing. 

Third memo to all:  Avoid (see above for definition of avoid) sponsors that claim to offer "next generation financial products." They don't exist. The only next generation that should concern you is is your grandchildren and not losing their inheritance.

Monday, December 04, 2017

UDF's Taint

I heard the rumor a few weeks ago that Houston-based independent broker dealer IMS Securities could close down due to an arbitration claim related to the sale of UDF IV, among other investments.  Today, InvestmentNews is confirming the rumor.  That's too bad.  Whether or not UDF is ever proved to have run ponzi scheme, as alleged, its other major flaws - affiliated dealings, high fees, high distributions supported by loans that generated no current interest, many of which were routinely extended, to name a few  - were clearly visible in filings. 

Wednesday, November 01, 2017

The Interval Fund Folly

I was at an industry conference last month and was told that there is a double digit number of interval funds in registration. I don't know if this is true, but I have seen plenty of new closed-end funds recently.  I do not understand the enthusiasm sponsors seem to have for these products.  They have better liquidity than non-traded real estate investment trusts and business development companies, which is good.  And the purchase process is easier and the suitability standards are lower than the non-traded products, too, but many broker dealers have implemented suitability standards for interval funds that are similar to those for non-traded products. 

Interval funds offer no deals in terms of fees.  Management fees are based on net asset value and are generally between 1.50% and 2.00% per year, which do not include other fund expenses.  Some interval funds invest in other funds and non-traded products, which have management fees, and potentially carried interest, all of which are in addition to the fees and expenses that the interval funds charge.  This makes a high annual fee hurdle rate that interval funds need to overcome, like 3.00% to 5.00% or more.  Combine these fees with the reality that most interval funds' underlying investments are not high flying investments, but modest return real estate investments, high yield debt investments, and fund investments, and you do not have an outlook for a high returns before any fees. 

Sponsors should check sales figures before entering into the costly interval fund registration process.  Through September, interval funds had raised a net $975 million in 2017, putting them on pace to raise $1.3 billion for all of 2017.  Just two interval funds have accounted for 70% of all sales in 2017.  Yesterday, the DI Wire published an article that says securitized 1031 exchange programs are on pace to raise $1.8 billion in 2017, which is half a billion more than interval funds.  Even the beleaguered non-traded REIT sector, and I exclude the sales of the Blackstone REIT, is on pace to raise $2.6 billion in 2017, or double the money flowing into interval funds. 

Money is leaving interval funds.  Some funds are seeing redemption rates of more than 20% of new sales.  This poses cash management constraints that could further weigh on performance.  Interval funds, in their current form, are not the savior of alternative investments, but an expensive niche investment for clients unsuitable for more sophisticated products.  Sponsors are spending millions to learn this lesson.

Tuesday, October 31, 2017

Four, Twenty, and Two Hundred Forty-One

Griffin Capital Essential Asset REIT announced a new NAV on Friday, October 27, 2017, of $10.04 per share, which was down from $10.44 per share as of October 27, 2016.  The drop in NAV is just under 4% at 3.8%.  This drop in NAV did not come as a shock.   It is only an estimate since the REIT is not traded on an exchange.  The following bullet point from the investor letter accompanying the valuation notice did surprise me:
The decline in NAV from last year stems, in part, from our close working relationship with our tenants as 17 of them (out of 84 properties) provided us with long-term notice related to space use expectations, influenced mostly by corporate mergers and restructurings. These advanced notices will potentially allow us to capture early termination fees which will offset the costs to re-lease the spaces to new tenants under long-term leases while taking advantage of favorable market fundamentals. While we did not include these potential benefits in this current estimate of NAV, we are optimistic that such potential will be achieved and accounted for in future NAV calculations.
The way I read the above passage is that tenants in 17 of the REIT's 84 properties, or 20%, have given notice that they plan to vacate their space.  At least that is how I read the euphemistic statement "provided us with long-term notice related to space use expectations."  Since nearly all of Griffin Essential Asset REIT's properties are single-tenant net leased properties, the REIT is looking at 20% of its properties being vacant.  A reference to the benefits of capturing lease termination fees confirms my thoughts on tenants vacating the properties.  So much for the concept of Essential Assets.

The REIT must spend the lease termination fees to obtain new tenants through lease incentives and improvements.  Since the majority of the REIT's properties are single-tenant, getting new tenants to take an entire building is going to cost the REIT money. 

Griffin Capital Essential Asset REIT had $3.36 billion in total assets as of June 30, 2017.  Its valuation had a estimated advisor promote of a whopping $241,000.  This meager incentive compensation estimate and a big leasing challenge signal to me that this REIT is not going to be seeking liquidity any time soon.