ARCT Listing

If you'd been listening it wasn't a bombshell, if you were incredulous it was a shock.  American Realty Capital has been saying for over a year that it was going to list the shares of its $2.1 billion REIT, American Realty Capital Trust (ARCT), as soon as reasonably possible after the REIT closed its equity offering.  It's an understatement to say I was skeptical about a quick listing, call me Captain Incredulous.  Early last week ARCT thumbed its nose at the doubters and filed an S-11 announcing its intention to list on NASDAQ on or near March 1, 2012, under the symbol ARCT.  ARCT closed its equity offering period in July 2011, and the speed with which ARCT has gone from non-traded to a pending listing is the quickest I can remember for a non-traded REIT.  Typically, before a non-traded REIT discusses liquidity options, it will have a minimum hold period of five to seven years from the date it closes its offering, and this this is a loose estimation, as a REIT's board can extend hold periods.  ARCT's quick path to liquidity will pressure other non-traded REIT sponsors to offer the same fast turnaround.

As part of ARCT's listing, it is internalizing its advisor and waiving fees, including any internalization fees.  An internalization fee has historically been a non-traded REIT sponsor's big payday, and is where the listing REIT, with the benevolence of investor capital, buys its external advisor, using REIT stock as currency.  The price the REIT pays for its advisor is the internalization fee, and historically this fee has run into the hundreds of millions of dollars.  The advisor typically determines its value (internalization fee), and than has the REIT pay for a third party "fairness" opinion that confirms the value.  Internalization fees have been under pressure for several years and typically trigger lawsuits from angry investors, the defense of which is paid for by the REIT.   (No comments, please, on Leo Wells $170 million internalization fee.   Although it has received the most press, it wasn't the most egregious internalization fee (other non-traded REITs had higher internalization fees both in term of dollar size and as a percentage of equity raised), it wasn't $170 million, and Leo Wells didn't pocket the entire amount of the internalization fee.)   I hope that ARCT's high-profile move to waive the internalization fee will put an end to this fee once and for all.

ARCT is not the first non-traded REIT to waive internaliztion fees.  Healthcare Trust of America waived its internalization several years ago when it internalized its advisor.  It too has filed an S-11 but has not yet listed on an exchange.   The large stock grants HTA keeps bestowing on its executives, to me, has made a joke of its ballyhooed internalization fee waiver.

ARCT will pay its advisor a 15% Subordianted Incentive Listing Fee (promote), which only gets paid if ARCT's stock trades above $9.81 per share 180 days from listing.  The S-11 desecibes the listing fee as follows:

"In connection with the listing of our common stock on NASDAQ, ARC or its affiliate will be entitled to a subordinated incentive listing fee equal to 15% of the amount, if any, by which (a) the market value of our outstanding common stock plus distributions paid by us prior to listing, exceeds (b) the sum of the total amount of capital raised from stockholders during our prior continuous offering and the amount of cash flow necessary to generate a 6% annual cumulative, non-compounded return to such stockholders. For this purpose, (i) the market value of our common stock will be calculated based on the average market value of the shares issued and outstanding at listing over the 30 trading days beginning 180 days after the shares are first listed."

Most, if not all non-traded REITs have a similar incentive listing compensation feature, but I have tended to gloss over it as few sponsors ever were in a position to earn it.  ARCT, according to an article in InvestmentNews, expects its stock's offer price upon listing to be $11.50.  ARCT's listing price is obviously unknown at this time, and its underwriter won't set a price until right before ARCT share are listed.  Once ARCT is listed its price will vary daily depending on the market.  ARCT's advisor gets its listing fee if, after 180 days,  the previous thirty-day average stock price is above $9.81.  If ARCT is able to execute its business plan and the stock trades above its original $9.81, it makes the loss of the internalization fee much less painful.   ARCT management has an incentive to perform because the higher ARCT's stock price, the more money that is paid to the advisor.   As investors make money so does ARCT.   The S-11 states that for each $.25 increase in ARCT stock price, the incentive listing fee will increase by $6.7 million.  The REIT will pay the listing fee, if any, in the form of a non-interest bearing three-year note.

Don't worry about bumping into ARC executives at the poorhouse due to a lack of internalization fee.  Upon listing, ARCT's chairman has 934,159 shares (received in stock grants from the REIT) that fully vest, and at $11.50 per share target price this is more than $10.7 million.  ARCT's president will have 212,370 shares vest upon listing, which at $11.50 is $2.4 million.  Other executives have shares that will vest upon listing.

The way I read the S-11 is that all ARCT shares will immediately be liquid upon listing.  This is a departure from recent non-traded REIT listings and filings where share releases to investors were deferred and provided liquidity over extended periods, typically twelve to eighteen months.  Immediate liquidity is favorable to investors, and hopefully the short listing period will inhibit unnecessary sales and downward pressure on prices.  ARCT is having a short-term tender offer period to help defuse sale pressure.  Any financial advisor that recommends selling ARCT shares to "reinvest" in another non-traded REIT is doing so only to earn another commission.

If ARCT trades at a premium to the $10 price investors paid for their shares it will be quite a coup for ARC management and, I suspect, a boon to its other non-traded REITs still in their offering period.   It will put pressure on other non-traded REIT sponsors to try and replicate the process - fast listing and working for the promote.  A successful listing (stock price trading at premium to the price investors paid for their shares) should kill the internalization fee for future non-traded REIT listings.