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*|
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.