June 28, 2012 will be remembered as the day the internalization fee officially died. As noted in the previous post, Wells Real Estate Investment Trust II disclosed yesterday that it will not pay to internalize its advisor. This is big news, real big news.
I don't imagine the decision was easy. Yesterday's filing, which detailed a prolonged transition period to self-management, and the payment of an asset management fee through 2013, indicates to me that there were probably tense negotiations between Leo Wells and the REIT's independent directors. While the independent directors may have been the driving force behind the no internalization fee push, Leo Wells should ultimately get the credit, because it's his name on the company and he had to agree to the final decision.
Internalization fees have become a four-letter word with broker / dealers and investors, and an automatic lawsuit button for attorneys. The negative fallout from Wells Real Estate Investment Trust's (now Piedmont Office Realty Trust) internalization still reverberates, and the internalization fee involved is mentioned in articles on non-traded REITs, and Leo Wells is presented as Exhibit A for non-traded REIT sponsor greed.* These factors probably made Wells REIT II's decision easier. But still, Wells REIT II is a $6 billion REIT and an internalization fee would have likely been in the hundreds of millions of dollars, so even after paying attorney fees for fending off lawsuits, there would have been a huge pot of money left over.
Almost all non-traded REITs retain language in their offering documents that allow for internalization fees, even with their negative perception in the market. I think only the American Realty Capital REITs and Griffin American Healthcare REIT II state in writing that they will not pay internalization fees to acquire their Advisors. (If I am wrong, or if you know other non-traded REITs that have explicit language eliminating internalization fees, please comment.)
American Realty Capital Trust's fee-waived internalization and listing early this year were a major step forward for investors and the non-traded REIT industry, and a challenge to other sponsors to follow ARC Trust's lead. Griffin-American Healthcare REIT II's and CB Richard Ellis Realty Trust's decisions to skip internalization fees were major tremors. Wells REIT II's decision yesterday was the final tectonic shift for the non-traded REIT industry. No sponsor can now charge an internalization fee. Leo Wells is as Old School as you're going to find in the real estate
syndication business, a product of the initial wave of real estate
limited partnerships in the early 1980s. When an industry icon like
Leo Wells makes the decision that it's time to forgo
an internalization fee, the fee is dead.
* Please, no comments on Piedmont's $170 million internalization fee.
This was the approximate amount at the time of internalization, not the value when Piedmont eventually listed, and I believe most of the
shares issued to Wells Real Estate Funds (i.e. Leo Wells) have not been
sold. Yes, it was a significant amount of money, but other sponsors
made more money, both in terms of the dollar amount of the fee and the
internalization fee as a percentage of original offering size.