Elephant In The Room

Last weekend the Wall Street Journal ran an upbeat article on daily net asset value non-traded REITs.  These REITs attempt to solve some of the valuation issues facing the non-traded REIT industry by valuing their shares daily.  According to the article, these REITs have positive features in addition to daily valuation, including low fees, improved pricing transparency and better liquidity when compared to the traditional non-traded REIT structure.  The article says that there are four daily NAV REITs being offered and an additional five in registration.  I am aware of three daily NAV REITs open to new investors.  Daily NAV REITs have everything going for them...except sales.  Two of the daily NAV REITs required sponsor investment to break escrow and the third has yet to break its escrow.  For a product type with so many positive features the initial sales of the three REITs are inauspicious.  Why?

Non-traded REIT sales in 2012 are booming, due in large part due to the successful listing in March of American Realty Capital Trust (ARCT) on NASDAQ.  When offered liquidity, many investors chose to sell their shares rather than stay invested in ARCT.  I can see the argument to sell at a profit, but based on the sales figures I am seeing from multiple non-traded REITs, I am guessing that ARCT sales are being recycled into other non-traded REITs.  By recycled, I mean financial advisors are recommending to clients that they sell ARCT, take the gain, and then use the sales proceeds to buy another non-traded REIT.   I don't agree with this strategy.  (Spare me the comments defending the  crap-excuse about clients somehow wanting an illiquid investment.  That rationale is complete nonsense.)   

Financial advisors originally recommended ARCT because they thought its business plan, management skill, high yield, stable income-generating property type or whatever other reason, made sense for clients.  These recommendations were made when ARCT was riskier because it was still a blind pool, didn't have all its equity or debt financing in place, wasn't generating cash to pay its distribution, among other risks.  Now that it's fully invested, it's at a less risky stage of its corporate life and validates the original investment premise.  Instead of holding the investment for its yield, it is being sold, and in many cases the sales proceeds are being reinvested in other non-traded REITs that are still raising and investing capital, and therefore at a riskier stage of their corporate life.   Why?

The one word answer to both questions is the same - commissions.  If a financial advisor chooses to charge a commission in a daily NAV REIT it is tacked on to the price of the investment.  Clients see exactly how much their financial advisor is being paid - for example, the client pays $10 for $9 of NAV.  Awkward.  In a traditional REIT, the commission is built into the price of the REIT and is not broadcast to clients.  As long as clients see how much their financial advisor is making in commissions, and there is an alternative where the client can't see the amount of commission, financial advisors will recommend the option where the client doesn't see the commission.  (In a traditional REIT the commission is disclosed in multiple forms and documents, it just is not immediately reflected in the share price.)

Financial advisor compensation is the only reason, in my mind, other than a drastic change in client financial circumstances or a reallocation away from real estate, to sell any newly listed formerly non-traded REIT, to buy another non-traded REIT in its initial offering stage.  ARCT paid financial advisors a nice upfront commission when the REIT shares were initially purchased.  The financial advisor can sell ARCT and earn another healthy commission from another REIT.

Let's be clear, I am all for financial advisors and broker / dealers making money.  I just don't see the point in selling a stable investment, which was sold as a long-term investment, to buy another similar, but riskier, investment except to earn another commission.