Rip Van Veres

I saw this Bob Veres' Financial Planning article yesterday morning.  I've read it a couple of times and wonder where Mr. Veres has been the past ten years.  (I will state upfront that this post is not a bash on Bob Veres just this one article, as I have read his material for nearly twenty years, and he has forgotten more about the financial planning industry than I'll ever know.)  Sorry to break this to you Bob, but non-traded REITs are not a "new category of investments."  The non-traded REIT business is now nearly a $100 billion industry, based on data I have seen recently published, and grew through steady equity raise of $5 billion to $10 per year over the past decade.  The comparison of the current non-traded REIT business to the limited partnership boom of the 1980s is weak. 

I broke into the broker / dealer industry in the late 1980s as a junior analyst assigned to the "continuing" due diligence department at a mid-sized independent firm.  Continuing due diligence was a fancy term for the saps assigned to field angry calls from brokers, and sometimes their clients, to tell them that their limited partnership investments were worthless.  A trial by fire.  Coming out of college, I had no clue what a partnership was, and in a short period my bosses that knew answers to questions were fired, so I had to educate myself.  Big partnership sponsors like August, Balcor, Equitec, VMS, Krupp and a slew of smaller ones all went away.  One of the biggest syndicators was Dallas-based Hall Financial Group, run by Craig Hall, which specialized in apartments.  He too failed.  (His afterlife has not been all bad.  His wife was an ambassador to Austria under President Clinton, Craig Hall's current firm is still doing real estate, and he and his wife run a respected wine business, although I won't buy a bottle.)  

The limited partnership business of the 1980s that Bob Veres is trying to compare to today's non-traded REIT business, was marked by massive failure.  Veres states that these deals collapsed under the weight of their fees, costs, expenses and deal structures.  This is true to a point.  Does anyone remember the infamous land deals that where structured as two offerings, one debt and one equity, where the debt investment was used to buy the raw land and the equtiy was used to pay interest on the debt and carry the land for a supposedly short period?   These deals did not end pretty.  I think a case can be made that a favorable tax code, which lead to the overbuilding of commercial real estate, and also caused the S&L collapse, hurt limited partnerships as much as fees.

Most limited partnerships lost their properties or were consolidated into other entities.   The term "Roll-Up" is still a four-letter word in the independent broker / dealer world because of the disastrous late 1980s and early 1990s roll-ups of Equitec, VMS and Krupp, which became the innocuous named entities Hallwood, Banyan and Berkshire, respectively.  Two roll-ups that kept their names, Realty Income Corp and Public Storage, worked out pretty well for investors that stuck around.

The non-traded REIT business of the late 1990s, lead by Wells and Inland, and since with multiple sponsors, has been marked by the lack of catastrophic failure.  This is amazing considering the 49% drop in commercial real estate prices from their 2007 peak.  Some REITs are struggling, as evidenced by net asset valuations of REITs like KBS REIT I, Inland Western, Dividend Capital's Total Realty Trust, Behringer Harvard's Opportunity I and others, which are all valued much less than the original $10 per share offer price.  But while these REITs have seen their net asset values drop, there is no talk (that I know of) of these REITs ceasing to exist.  As noted above, commercial real estate in the 1980s was driven by a favorable tax code that lead to signfianct over building.  Commercial real estate in the 2000s did not, for the large part, have the overbuilding that marked the 1980s, which has helped the non-traded REITs keep their properties occupied.  The non-traded REITs, in general, do not have the high levels of debt that was common in the 1980s.  These factors, in my opinion, have helped the non-traded REITs avoid the problems that faced limited partnerships in the 1980s.

I think Mr. Veres' article would have been stronger and more relevant, if he'd compared the limited partnership industry of the 1980s to the TIC boom of the 2000s.  This is the better analogy because both were marked by tax driven investors looking to avoid or defer taxes as first consideration, and both had highly leveraged properties.  And like the limited partnerships of two decades ago, it's my opinion that most TIC deals will end up being lost to foreclosure, or more likely consolidated with other TICs.  I don't believe TIC consolidation is a four-letter word, but that's a subject for another post.

The end of Veres' article falls further when he discussses non-traded REIT earnings.  He lists some non-traded REIT earnings, all that are bad.  He needs to focus on Funds From Operations (and NOT Modified Funds from Operations).  FFO for REITs, whether listed or non-traded, is the most widely recognized metric for financial health, due to the large amount of non-cash write-offs afforded REITs.

Another area that separates the 1980s' partnership boom and today's non-traded REIT business in the independent broker/dealer business, itself.  I don't have specifics, but I would guess many independent broker / dealers had partnership business that was probably 50% or more of their total revenue and needed partnership sales for their survival.  Today, broker / dealer executives break into a cold sweat if alternative investments (under which non-traded REITs fall) are more than 10% of revenue. 

One area where Mr. Veres focus was correct was raising the specter of Robert Stanger & Co. in the limited partnership boom of the 1980s and today's non-traded REIT industry.   I'd like to know more about this, too.   It is good that Bob Veres has turned his eye to this "new category of investments," and non-traded REIT sponsors better be ready if a bearded man with a ponytail stands up at a conference and starts asking pointed, uncomfortable questions.  He doesn't take BS for an answer.