Tuesday, December 04, 2012

If A Fee Falls In A Forest

AR Capital has made a subtle change to the compensation structure of its non-traded REITs.  Rather than take an asset management fee in cash, it has opted to take the asset management fee in units of the operating partnerships through which the non-traded REITs own and operate their real estate.  AR Capital has subordinated receipt of this fee to investors receiving a return of capital, plus a specified annual return, generally 6%, resulting from a liquidity event.  So, before AR Capital gets its asset management fee, it must return an investor's original investment, plus 6% per year.  Payment of the asset management fee is therefore not assured.  This is separate from any other incentive compensation AR Capital may earn from its REITs.

Asset management fees provide sponsors with steady, recurring revenue, which is not based on any performance or return to investor hurdles.  The asset management fee, because of its predictability, is a disincentive for sponsors to provide liquidity to investors, especially if liquidation incentive fees appear unobtainable. Over time, the asset management can become the only compensation a sponsor is ever going to receive.  When a non-traded REIT lists to go public, one of the first changes is elimination of the asset management fee, which tells you all you need to know about the validity of this fee.

I have not read of or heard of any other sponsor following AR Capital's lead.  Frankly, I'll be surprised if other non-traded REIT sponsors emulate the ARC fee change, even though they should.  Until investors, brokers and broker / dealers cry about this fee, or start making investment decisions contingent on this fee, sponsors will let AR Capital defer its fees while they keep collecting the asset management fee.   Because the asset management fee is generally stated in small percentage amounts - 1% or .75% of asset value, for example - its insidious impact - particularly over the long-term - is overlooked. It locks investors into a REIT because sponsors have no incentive to provide liquidity and stop receipt of the asset management fee.

While the above is all good and well, if AR Capital's focus is to get its REITs' equity raised and invested, and then provide REIT investors liquidity through a sale or listing, why not eliminate the asset management fee altogether?    If AR Capital eliminates asset management fees, its competitors will feel the pressure from broker / dealers to cut or eliminate asset management fees.  Investors will be the real beneficiaries of lower fees.


Anonymous said...

This is the difference maker!

Anonymous said...

June is coming fast, can Cole do anything but talk?