TIC News
The first quarter TICTALK newsletter put out by Omni Brokerage had some interesting information. The TIC industry rasied $3.2 billion in 2005, up from $1.8 billion in 2004, an 82% increase. Omni projects the TIC industry will raise $5.5 billion in 2006, a 70% increase over 2005's record. Omni's information survey covered 68 TIC sponsors. The major property types were office and multi-family. The Other category which accounted for 1% of assets in 4Q 2004, jumped to 21% of money raised in 4Q 2005. This category included oil and gas, hotels, assisted living and self storage. Not sure what to make of this other than it's likely sponsors attempting to find properties that will throw off enough yield to make their programs marketable.

The Beauty of Back-of-the-Envelop Calculations
I have been calculating potential IPOListing prices/valuations for public non-traded REITs for sometime. I use a simple FFO multiple to determine a possible stock price. (FFO is Funds From Operations and for REITs is the equivalent of Earnings Per Share. So, an FFO multiple works similar to a P/E ratio for stocks.) I use a multiple of 8X to 12X, which is the historical range, although the current multiple is close to 14X.

Non-traded REIT sponsors do not like this calculation and avoid it as much as possible because most valuations come in below the non-traded REITs initial offering price. For the first time that I have seen a non-traded REIT has put this valuation method in print. The rational is the FFO valuation is too low and investors need to vote to liquidate the REIT’s portfolio rather than pursue a public stock listing through an IPO. You don’t say.

Putting the FFO metric to work on other REITs will likely result in similar below par valuations.

Here is an example. An initial $10 offering price gives an FFO of $.70 per share. Calculating times the historical range and current high give the following:

$.70 X 8 = $5.60 per share

$.70 X 12 = $8.40 per share

$.70 X 14 = $9.80 per share

While not exact, this back of the envelop calculation shows why the non-traded REIT sponsors are so anti-FFO.

Vanishing Risk Premium or Buyer Beware

I read through a supplement to a major non-traded REIT’s prospectus over the weekend (yes, exciting life). It has bought interests in water parks in Wisconsin and Ohio (that includes hotels) and a sky lift in Tennessee. Maybe I am missing something, but how many months a year is a water park in Wisconsin viable. This is REIT is paying a 5.5% yield. I am not against these investments, but to me, these investments represent opportunities that warrant more than return than a 1% over a ten-year Treasury.

Here is the latest property visit I made. It is a 342,686 sq ft office building in Ft. Lauderdale. The sponsor, as part of the purchase, is selling the underlying lot to an insurance company, so the tenant-in-common investors are just purchasing the building. Very interesting structure and on paper is adding close to $6 million in value. 

Another One...
I just saw another TIC offering with negative leverage. Like the post mentioned below, this deal has a mortgage rate that is expected to be 5.6%, and the cap rate (return) is 4.9%, inclusive of all the fees and reserves of the offering. This apparent economic disadvantage is easily solved. The sponsor has reserved cash to supplement the distribution for the first three years and the mortgage is interest-only for the first three years. Oh, and the growth rate on the Net Operating Income is projected at more than 4% annually. OK. Looks good on paper, but watch that distribution in the fourth year.

Risk Premium

Where did this go? It has always been overlooked, but it’s about time to revisit the Risk Premium of these illiquid alternative investments and make the reader aware of the returns they should require. Based on investment size and illiquidity alone, the risk premium for real estate securities, in my opinion, requires at least a 300 basis point premium over the comparable US Treasury. Add in deal specific risks and the Risk Premium gets even greater. How many programs are offering returns 400 basis points over their comparable US Treasury? I’m waiting…..

Cracks in the Armor
Last month I saw my first Tenant in Common offering that had negative leverage. The sponsor was purchasing the property around a 4.9% cap rate (inclusive of all fees) and had debt with an interest rate around 5.7%. Ouch - a 70+ basis point negatvie spread. So why would anyone invest? Make the loan interest-only for the first five years and project annual rental growth rates of around 4% and that pesky negative leverage disappears. Presto! Oh, and hold the property for twelve years.

Welcome to the Rational Realist. This site will provide comment, insight and analysis on the world of alternative investments, in particular real estate securities and other direct investments. I have close to twenty years experience analyzing investments and am a Chartered Financial Analyst. The site is not meant to provide investment advice. Most posts will be opinion-oriented and most evidence anecdotal. Any facts will be stated as such.