Moving Forward

Here is a Bloomberg article stating that Cole Credit Property Trust III (CCPT III) plans to review and meet with American Realty Capital Properties (ARCP) to discuss ARCP's latest offer.  ARCP revised its offer for CCPT III yesterday, and upped its cash offer to $12.50 per share and guaranteed to pay at least $13.59 for each CCPT III share.  ARCP's offer yesterday included a proposal to acquire Cole Holdings, which was not part of last week's original buyout offer.

That's Some Scary News, George Bailey

I have not followed the financial crisis in Cyprus, but this is alarming:

Under the terms of the bailout, the second largest lender, Cyprus Popular Bank, is to be shut down and its accounts of under 100,000 euros combined with those of the Bank of Cyprus. Accounts of more than 100,000 euros at both banks will be frozen, with depositors, many of them rich foreigners, likely to lose much of their investments.

By protecting state-guaranteed deposits of up to 100,000 euros, the bailout reversed a previous deal struck on March 16 that would have imposed a levy on small depositors as well as big ones, which had infuriated Cypriots and was vetoed by parliament. Government officials have estimated big depositors could now face loses of around 40 percent.

Accounts greater than 100,000 euros are looking at losses of 40%, which will be taken directly from accounts.  A strange twist is how much Russian money is in Cyprus' banks.  It's estimated that 31 billion euros, or a third to one-half of all deposits have Russian origin.  Cyprus' banks are set to re-open tomorrow, and "run" is not a strong enough word to describe what's the banks are going to experience when they open their doors.

Update:  Cyprus plans to open its banks tomorrow, Thursday.

Update II:  Apparently, there was no run on Cypriot banks

Cole Merger Article

Here is a good article from InvestmentNews on Cole Credit Property Trust III's decision to dismiss the American Realty Capital Properties (ARCP) buyout offer and maintain its intention to proceed with the internalization of its sponsor, Cole Holdings.  The article was written before CCPT III's 8-K filing yesterday morning, which provided more detail on why it rejected ARCP's offer.  After reading this article and yesterday's filing, I am still of the opinion that Cole needs to provide more information to investors before they can make an informed decision on the merger.  Wait, I almost forgot, the Cole's proposed merger doesn't require a share holder vote.   That's a shame.

Merger Update

I'm traveling and can't properly comment on the latest goings on between Cole Credit Property Trust III (CCPT III) and American Realty Capital Properties (ARCP) until later in the weekend.  In short, ARCP has offered to buy CCPT III for $12.00 per share or .80 of ARCP stock for each share of CCPT III.  Yesterday, CCPT III's board rejected the offer and affirmed is decision to go ahead with its plan to buy its sponsor as originally intended.

On the surface it seems to me that CCPT III needs more explanation as to why it's rejecting ARCP's $12.00 per share offer.  ARCP's bid eliminates the $150 million internalization fee to Cole, which likely explains the real basis for CCPT III's decision.

I'll post longer over the weekend.

Note that in an earlier post I didn't know whether the Cole transaction included eliminating the annual asset management fee.  It does and Cole will no longer receive an asset management fee.  The ARCP transaction also eliminates the annual asset management fee.

Ireland's Shining

There was good news out of Ireland this week, which has wider implications as a sign that the credit crisis is ending in parts of Europe.  Ireland was able to sell 10-year bonds for the first time since it was bailed out in 2010.  Ireland's initial intent was to sell 3 billion euros of bonds but increased the size to 6.5 billion euros on investor demand.  This section of a Bloomberg article details the bond auction:

The yield on the bond was 240 basis points over mid-swaps, a fixed-market benchmark, according to the person. The sale attracted at least 12 billion euros of bids, according to two people.

The NTMA last issued 10-year bonds in 2010, before the near-collapse of the country’s banking system prompted investors to shun the nation’s debt. In November of that year, the Irish government asked for a 67.5 billion-euro international rescue in a three-year program.

The NTMA hired Barclays Plc, Danske Bank A/S (DANSKE), Davy, HSBC Holdings Plc, Goldman Sachs Group Inc. and Nomura Holdings Inc. as joint lead-managers for the transaction.

“This represents an important milestone in the country’s re-engagement with the bond market,” said Philip O’Sullivan, an economist at Dublin-based NCB Stockbrokers today. “Ten-year issuance could have important ramifications for Ireland’s credit rating and its plans for a successful exit from the bailout program at year-end.”

The yield on the Irish 5 percent bond maturing in October 2020 has fallen from a euro-era high of more than 14 percent in July 2011 to 3.65 percent.

The Double-Dip Express

Cole Credit Property Trust III's (CCPT III) letter to investors last Wednesday, and this Seeking Alpha article call CCPT III's acquisition of its sponsor "transformational."   A better word is "retro." The merger is resurrecting a dead fee.  CCPT III is reversing full speed to the early 2000s when non-traded REITs routinely paid big internalization fees to acquire their external advisors.  I thought those days were gone, and even proclaimed the final passing of internalization fees last summer when Wells REIT II announced it would not buy its external advisor.  Sponsor's don't forget big paydays, however, especially when they don't require shareholder vote as in the case of CCPT III buying its sponsor, Cole Holdings.   Cole's move shows the internalization fee is alive and flourishing; a Phoenix that just won't stay dead.

Buried deep in a filing CCPT III made last Friday, is the share price over which Cole starts to earn its subordinated incentive listing fee.   This share price is $10.45.   After 180 days, if the newly listed stock's average price for the subsequent thirty days exceeds $10.45 per share, Cole receives 15% of this profit in stock.  (Cole has agreed to reduce its subordinated incentive listing fee by 25% due to the internalization fee.)  Cole only receives this fee after investors have received a full return of their capital plus an 8% annual return.

I am not going to try and predict the future price of the CCPT III/Cole Holding stock when listed, but is $10.45 that far out of reach?  The market's reaction to the two recent American Realty Capital Trust transactions (three if you include Realty Income Corporation's purchase of ARC Trust), the WP Carey and CPA 15 transaction, and even the Cole Credit Property Trust II / Spirit Realty transaction, makes it apparent that the market likes the steady income of long-term net leased real estate.  If you include CCPT III's dividend increase and the expected accretive benefit of the transaction, $10.45 seems closer than ever.

Subordinated incentive listing fees - not internalization fees - were designed as a sponsor's big payday.  After a non-traded REIT returned investor capital plus a preferred return, a sponsor shared in profits.  Subordinated incentive listing fees are not assured, which, I am guessing, is why Cole is leaving nothing to chance and is taking a large internalization fee, which is nearly $150 million at a $10 per share stock price, and obviously more if the stock price exceeds $10.00 per share.

Based on in formation in last Friday's filing, I have created the following table showing the internalization fee, including the fee at a 25% discount, at various stock prices for the new Cole Real Estate Investment:

Cole Credit Property Trust III Potential Subordinated Incentive Listing Fee*
Shares Outstanding	481,367,453
Share Price	$10.00	$10.45	$10.75	$11.00	$11.50
Value	$4,813,674,530	$5,030,289,884	$5,174,700,120	$5,295,041,983	$5,535,725,710
Profit	$(216,615,354)	$-	$144,410,236	$264,752,099	$505,435,826
15%Profit Sharing	$-	$-	$21,661,535	$39,712,815	$75,815,374
25% Discount			$16,246,152	$29,784,611	$56,861,530

I determined Cole's potential Profit at several share price levels.  I first determined several possible market capitalizations by multiplying the number of Shares Outstanding by potential stock prices.  To determine Profit, I then took the difference between the various market capitalizations and the market capitalization at $10.45 per share.   No Profit is earned until the share price exceeds $10.45 per share.  Above $10.45, Cole's subordinated incentive fee is 15% any Profit.  Before Cole receives this fee, investors will have received a full return of their original investment, plus an 8% annual return. 

The table also shows Profit Sharing less 25%, which is the amount that Cole is reducing any subordinated incentive listing fee due to it taking an internalization fee.  This is the amount added to Cole's internalization fee.

I am not aware of another instance where a sponsor received both an internalization fee and a subordinated incentive listing fee.  I am sure that it's partly the case that prior non-traded REIT listings or liquidity events where the sponsor received an internalization fee never had subsequent share prices high enough to pay the subordinated listing fee.  The inability to earn a subordinated listing fee is one, if not the main reason why non-traded REIT sponsors began taking the internalization fee in the first place.

If the CCPT III's purchase of Cole Holdings is accretive - and I am all for accretive deals that add full liquidity - why doesn't Cole just take its compensation in the form of the full 15% subordinated incentive listing fee.  The more money investors make, the more money Cole makes.  If investors receive a big payday, no one would care, and no one would complain if Cole takes home $75 million ($11.49 per share), or $150 million ($12.53 per share), or $300 million ($14.60), or more.  It's the dang internalization fee that is so troubling. 

I am sure other non-traded REIT sponsors are watching this transaction closely.  If Cole can pull off the duel fees - internalization and subordinated incentive listing fee - and not damage its brand (ability to raise equity through broker / dealers) going forward, I suspect other sponsors will leap back on the internalization train.  Investors better put on a seat belt and grip their wallet tight because its "All Aboard the Double-Dip Express!"

* I determined the figures in the table above based solely on my reading of CCPT III's filed documents, without any verification of any share adjustments or valuation formulas and are for illustrative purposes only.

Internalization Fee And Then Some

On Friday Cole Credit Property Trust III (CCPT III) released an 8-K that included the merger agreement between it and Cole Holdings, and the compensation arrangements between the new company and Christopher Cole and Marc Nemer.  If a $150 million internalization fee was not enough, as part of their compensation agreements with the new company, Mr. Cole and Mr. Nemer will receive shares in the new entity of $7.5 million and $6.0 million, respectively, payable when the merger closes.  These long-term incentive and retention awards are:

subject to mutually agreed upon future employment and performance conditions and are expected to be reflective of the standard vesting and market practice for awards granted to the most senior executives of similarly situated companies in connection with a new equity listing. 

I find it hard to believe the stock grants won't get realized.  Apparently, according the the 8-K, awards of this nature are "customary."  Really?  I want some of this custom.  Return of investor capital plus the preferred return better be one "performance condition."   I'll add this compensation to the overall level of fees CCPT III investors are paying to buy CCPT III's sponsor.

Payback, Baby!

When Cole Credit Property Trust II (CCPT II) announced its merger with Spirit Realty earlier this year and there were no internalization fees to CCPT II's advisor or sponsor, a little voice inside my head kept saying this is too good to be true.  That little voice is crowing so loud this morning I am starting to get a headache.  Cole's altruism in CCPT II has morphed into avarice in Cole Credit Property Trust III.

Cole Credit Property Trust III (CCPT III) announced in an 8-K filing this morning that it is purchasing an affiliate, Cole Holdings Corporation.  The merged entity is changing its name to Cole Real Estate Investments, Inc., and plans to list on the NYSE in the second quarter.  This is a liquidity event for investors in CCPT III.  The new entity, Cole Real Estate Investments, Inc., is increasing its distribution to a 7% yield for a CCPT III investor.

CCPT III is paying a handsome price for its affiliate.  It is paying $20 million in cash and 10,771,225 in shares of Cole Real Estate Investments.  If you value the shares at the $10 per share price paid by investors for their shares of CCPT III, this equals $107,712,250.  The REIT pays Cole another 2,142,245 shares once the new entity lists on the NYSE, and again assuming the $10 per share price, this is another $21,422,450 million.  The grand total is $149,134,700.   The shares paid have a lock-up period, with one-third released on closing and then the remaining two-thirds released in two annual increments. 

There is an undisclosed "earn-out" amount determined in 2017, and payable at the end of 2017, based on the Cole Real Estate Investments hitting performance objectives not listed in today's filing. 

Wait, there is more.  The REIT's advisor still can receive a subordinated listing fee:

Upon listing of the Company’s common stock on a national securities exchange, a fee equal to 15% of the amount by which the market value of the Company’s outstanding stock plus all distributions paid by the Company prior to listing, exceeds the sum of the total amount of capital raised from investors and the amount of cash flow necessary to generate an 8% cumulative, non-compounded annual return to investors will be paid to CR III Advisors (the “Subordinated Incentive Listing Fee”). 

The subordinated listing fee is not paid until investors get a specific level of return - their investment in CCPT III plus 8% per year.  This fee, if earned, is paid six months after the listing.  Cole is reducing it by 25%.

CCPT III is externally advised by an affiliate, and I didn't read in the filing that the REIT internalized its advisor, so I am assuming that the REIT will continue to pay an asset management fee .50% on its average invested assets.   CCPT III had more than $7 billion in assets at September 30, 2012.

This is a great deal for Cole.  It circumvented the whole stigma of the internalization process but still takes home $150 million (assuming a $10 stock price), with the possibility of much more.  Not only that, it still keeps its asset management fee of .50%.  I think this is called having your cake and eating it too, with ice cream, whip cream, a cherry and chocolate sauce on top. 

I don't want to come off completely negative.  It's positive that CCPT III investors are getting liquidity, and it's positive that investors that elect to keep their shares are getting a distribution increase of $.50 per share, or nearly an 8% increase.  CCPT III closed its offering period just about a year ago, so the time to liquidity was much faster than anticipated.  From what I read it's a fully liquidity event for investors, not a multi-tranche staged liquidity.  The market and investors will ultimately judge the merits of this transaction.

UPDATE:  In the original post I forgot to included that Cole is reducing its subordinated asset management fee by 25%.  I have added it above.

I didn't read in the filing today that CCPT III internalized its management.  One of the bullet points in the filed presentation states that the REIT will no longer pay external management fees.  This could read property management fees, asset management fees, or both.  I took it as property management fees because the property manager is part of Cole Holdings, which is being acquired by CCPI III.  Another bullet point states that Cole Real Estate Investments will earn property management fees from other non-traded REITs sponsored by Cole, in particular Cole Credit Property Trust IV and Cole Corporate Income Trust.

Fantasyland Meets The Real World

A strange dichotomy occurred yesterday in the non-traded REIT world.    Behringer Harvard Multifamily REIT I announced in its 10-K a value of $10.03 per share.  It derived part of its value by capitalizing 2013's estimated net operating income at cap rates based on a property's region.  The cap rates used ranged from 4.3% to 5.2%, with an aggregate cape rate of 4.7%.  It's a forward cap rate based on 2013's expected net operating income, with aggregate revenue growth projections of 5.4% 

It took a few seconds to put my eyes back in my head after reading these assumptions.  I won't quibble with the low cap rate estimate because the esteemed Duff & Phelps - assumption confirmer extraordinaire - reviewed the REIT's valuation methodology.  If cap rates are really this low, this REIT should liquidate its portfolio as soon as possible.

Back in the real world, American Realty Capital Trust III (ARCT III) and American Realty Capital Properties completed their merger and the combined company's stock began trading yesterday morning under the symbol ARCP.   ARCT III investors now have fully liquid shares of ARCP.  ARCP stock closed at $13.11, which gives ARCT III investors a fully liquid value of $12.45.  This is a simple return of 24.5%, exclusive of any distributions. 

A non-traded REIT's advisor can derive any value it wants, but because a non-traded REIT is just that - non-traded - its value is a guess created from an alchemy of advisor self-interest.  To me, until a non-traded REIT is priced by the market, its value estimate is not worth the price paid for it.