Monday, April 04, 2011

If You Can't Beat Them, Join Them
I was alerted in a comment to this blog that American Realty Capital Trust has awarded its executives shares of restricted stock.  Here is the wording from the post-effective amendment that American Realty Capital Trust filed on March 11, 2011:
On September 13, 2010, our advisor granted 934,159 restricted shares of common stock to Nicholas S. Schorsch, chief executive officer of our advisor, 212,370 restricted shares of common stock to William M. Kahane, president and chief operations officer of our advisor, 160,604 restricted shares of common stock to Peter M. Budko, executive vice president chief investment officer of our advisor, 55,270 restricted shares of common stock to Edward M. Weil, Jr., executive vice president and secretary of our advisor and 37,597 restricted shares of common stock to Brian S. Block, executive vice president and chief financial officer of our advisor. Fifty percent of the restricted shares vest over a four year period commencing with the one year anniversary of the September 13, 2010 grant date and 50% vest only to the extent our net asset value plus the distributions paid to stockholders equals 106% of the original selling price of our common stock.
On June 2, 2010, American Realty Capital Trust announced that it was waiving any internalization fees in the event that it internalizes its external advisor as part of of a sale or listing American Realty Capital Trust's shares on an exchange.  The awards above came about three months after the announced waiver of any internalization fees.   The pool of stock available to award is up to 7.5 million shares, which at $10 per share is $75 million.   In the quote above, at $10 per share, the awards last September are worth nearly $10 million to Nicholas Schorsch and over $2 million to William Kahane. The bulk of the shares that American Realty Capital Trust can allocate to its executives is still available for allocation.

Internalization fees can be lucrative to the external advisor, and some non-traded REITs have paid more than $100 million for their advisors.   American Realty Capital Trust's decision to waive internalization fees was positive for investors.

The company that distributes American Realty Capital Trust is Realty Capital, which also distributed Healthcare Trust of America (HTA).  HTA waived its internalization fees in 2009, but recently expanded its pool for executive and board member stock awards by $80 million.  It looks like American Realty Capital is following HTA's path.

Half of the American Realty Capital executive stock awards are deferred over four years and half vest only "to the extent our (American Realty Capital Trust) net asset value plus distributions paid to stockholders equals 106% of the original selling price of our common stock." 

To me, American Realty Capital's granting of large amounts of stock to its executives is another form of an internalization fee.  The large amount of stock was issued by American Realty Capital Trust after the announcement that there would be no big pay day when it purchased (internalized) its advisor, plus American Realty Capital has plenty more stock it can grant its executives.  Like HTA, American Realty Trust appears to have figured a way around its waived internalization payday.


Anonymous said...

I read the filing differently. First, looking closely at ARCT’s 10K, the entire award to management is 1.5 million shares ($15 million). Not sure how you are arriving at $75 million. Second, only half the award is time vested. The other half is purely performance based and is paid only after the investor receives 100% of his/her capital back plus a non-compounded annual 6% return on capital. Finally, no vesting occurs at all for two years, and the award vests over a five year period. My take is that the independent board made the stock award based on management’s exemplary performance to date. Seems to me there is a big difference between this type of award and an internalization fee which seeks to retain management, irrespective of performance. At the end of the day, ARCT’s restricted stock plan is pay for performance. It merely recognizes the results achieved.

Rational Realist said...

Thanks for the comment. In the post-effective amendment (page S-37) it states that "Restricted stock awards under our employee and director incentive restricted share plan may not exceed 5% of our (ARCT's) outstanding shares on a fully diluted basis at any time, and in any event will not exceed 7,500,0000 shares (as such number may be adjusted for stock splits, stock dividends combinations or other similar events)." While you're right that there is an incentive feature (or subordination feature), it is not 100% of capital plus 6% per annum. It is when ARCT's net asset value, plus distributions paid equals 106% of the original selling price of the stock, which would be $10.60 per share. I need to make a clarifying post.

Anonymous said...

The person who made the first comment is missing the main point. This is not common practice within the non-traded industry. ARC sold HTA which awarded its management team and board, before any liquidated event. Now ARCT is doing the same thing with its management team.

Direct quote from the earlier post: “My take is that the independent board made the stock award based on management’s exemplary performance to date.”

Once there has been a liquidity event in the REIT and all the shareholders receive a return of capital and preferred return – then you can state management has done their job. Until then – all they are doing is taking fees and diluting shareholders overall return.

Anonymous said...

I'm a financial advisor with a small independent BD, so we don't have the same resources that our wirehouse peers may have, so bare with me. My local ARC wholesaler shared the ARC Trust has been valued at $12-14/share and will listed by year end, I'm curious how this valuation is done? I've yet to see Retail Real Estate values increase anywhere, and am a bit suprised their fund is up 20-40%, not to mention the various fees that must be overcome. any insight on this?

Rational Realist said...

You are right. Fees need to be overcome and it's hard to believe that real estate recently purchased can increase 20% to 40%, or more if the fees are included.

I am skeptical that ARCT can close its offering by the end of July and be fully listed by the end of the year, at a 20% to 40% premium. Other non-traded REITS that have listed or in the process of listing are using a deferred release of shares for investors. The release of shares is over 12 to 18, to maybe up to 24 months. This is done to prevent large blocks of sales which would drive down price.

Valuations are based on a variety of factors, but I would guess that the wholesaler is using a multiple of ARCT's FFO, or expected FFO. Other factors that would impact FFO multiples include size, expected FFO growth, leverage and quality of the real estate and tenants.

Non-traded REITs are not an arbitrage play.

eric said...

If they plan on listing this year the shares given to the insiders would not be vested and have little immediate value? So they would be dumped if listed at year end.
Aren't these shares accounted for? These are not new shares that dilute the current value by increasing the overall share amount ? in the past the internalization cost just prior to listing added the share count and was dilutive and was used by management to cash out of some of their holdings.... If my clients get 100% of principal back after getting the 7% dividend it will be a win in the world of non traded reits

eric said...

I meant to say that they would not be dumping shares since they would not be vested

Rational Realist said...


If ARCT can get 100% principal back plus the 7% it's win for everyone. That would be awesome if that happens. I'm not saying that management would dump its shares if ARCT lists. The liquidity of its shares have different trigger points.

Anonymous said...

Wrong again!