Wednesday, March 06, 2013

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.


Anonymous said...

First of all, thanks for all of the writing you do, and I'm glad you jumped on this so quickly.

I'm just looking at the filing right now, and I think your comment about the internalization is incorrect. The whole merger is about the internalization, and the payments are compensation for the acquisition of the advisor (and all of its fees). So there will be no more 0.50% asset management fee, which is why they can afford to increase the dividend.

And with regards to the additional shares they can earn (after 180 days of trading) - they did agree to reduce the amount by 25%.

Still a steep price to pay, but it seems like it's accretive, which speaks to their scale. In addition, the REIT begins to earn the advisory revenue (property management and asset management fees) from other REITs managed by the advisor (CCPT I & III), so CCPT II investors get the benefit of that additional revenue.

I don't work for Cole, just deducing that from what I see and my knowledge of how the industry works.

Anonymous said...

They are paying for it (mainly in shares) but also getting the benefit of the ongoing fees that will be generated from this product and others as Cole raises more money in the non-traded arena. This is different than an internalization fee because shareholders receive an actual positive cash flowing company rather than just paying a company because they will no longer be receiving fees.

ARC has done the same thing with around 100mil of options on each deal they have brought to market while not giving shareholders anything in return. Keep in mind the ARC deals were much smaller as well.

This is my perception, but I could definitely be wrong. Let us know what you think as you look at it more.

By the way, it isn't like I think Cole is getting nothing out of the deal, but it seems as fair as any other deal that has come to market lately that didn't charge "internalization fees".

Anonymous said...

My concern is what the IPO will be and what the profit will be for the CCPT III shareholders right off the bat, seems alot better for COLE then for CCPT III

Rational Realist said...

Anonymous 1, thanks for the comment. I forgot to add the 25% reduction and have corrected the post. I hope you're right about the internalization, but I didn't specifically read it in the filing. I will update as I receive clarification.

Anonymous said...

Yes. This it is an internalization. Cole Holdings is the Advisor for CCPT III and all the other "Cole" branded REITs.

This is a way for Cole brass to monetize the Advisory business and gives them a public traded platform to continue to operate from.

They are effectively turning the Advisory company into a public entity that also owns real estate--will be very similar in structure to WP Carey.

I can say that with relative confidence as I work in the non-traded REIT industry and I actively follow all the big players.

Spectator said...

I'm reading this as a sign for the industry. Cole, one of the largest sponsors, appears to be exiting the non-traded REIT game (barring the legacy programs of course). The writing is on the wall as the industry continues to reel from a business model that doesn't make any financial sense.

A fund acquired the sponsor/parent and chose to go public 1) for fees and 2) for longevity. Perhaps Cole management didn't think they could continue to raise money as a non-traded sponsor. This way they can live on as a publicly traded entity.

Gotta applaud the sponsor for it's ability to adapt to a changing landscape. A job well done.

Anonymous said...

I disagree with your assessment. As others have mentioned, this is pretty much the same platform as WP Carey operates. They have been very successful as a sponsor of non-traded REITs as a publicly traded REIT.
I do think you will start to see changes in product structure within the NTRs in terms of thinner loads (less up-front commissions) and more frequent appraisals and transparency. All positive changes for the industry.
But as far as this being an indication of Cole leaving the NTR space...I disagree.

Anonymous said...

Shame on Chris Cole and the firm for taking these high fees for no performance.

I'm done selling this product.

Anonymous said...

I don't get it. Why did the Cole III Board of Directors agree to purchase their sponsor?

They certainly could have procured a new management team at a price less than nearly $150 million!!

That would have avoided the dilution that will result from issuing shares at such an above market price. They could have invested the cash in real estate instead which could have been accretive to distributions.

Anonymous said...

I view this as taking new fees and changing the rules on our clients. And if your clients plan on reinvesting with you, the sponsor is taking from your income as well. And just because investors don't know the fair price of the IPO on the NYSE on day 1 or day 2 its really worse not better. Thinking hey maybe this is worth $11, $15, $20 a share well what if Cole III trades at $8.00? Fee still is just as unfair. If this was to be done fairly why is there not any type of price support established. Perfect example of putting negative skin in the game.

Anonymous said...

Re: Asset Mgt Fee..
"Not only that, it still keeps its asset management fee of .50%."
Is that fee a charge to the property management company? Is that a standard/average fee? I'm trying to uncover what another REIT received from its Property Manager. My lease has this as an exclusion (i.e. payments to affiliates) but they passed it through anyway. I would love to figure it out. Thanks,