In The (No) Money

This blog has been harsh on Cole Credit Property Trust III's decision to acquire its sponsor.  But I need to point out what's happening with Cole Credit Property Trust II (CCPT II) and its merger with Spirit Realty (SRC).  Back when it was a game to speculate about CCPT II's liquidity plans, I determined that for Cole to achieve its subordinated listing fee, its stock would have to trade above $11.06 per share.  This was as of September 2012, and was probably high based on the timing of all investors into CCPT II, but then a few more distribution periods have passed that would have increased the price.  So, I am guessing an "in the money" price of $11.06 is not too far off the mark, over which Cole gets a 15% subordinated incentive listing fee.   Today, SRC's stock closed at $21.53 per share, giving a CCPT II conversion price of $11.30 per share ($21.53 times the conversion ratio of .525).

There is only one problem.  Cole waived any subordinated incentive listing listing fee when it agreed to the merger with Spirit.  With an agreed upon January merger price of $9.36 per share for CCPT II stock, waiving a incentive that that required a nearly $2 per share appreciation (nearly $4 for SRC) over six months was probably not a tough decision.  Conversely, I imagine that Cole probably could have kept the subordinated incentive listing fee for the same reason.  I could also argue that since SRC's management is going to take over the combined SRC / CCPT II portfolio, it needs deserves credit for the stock increase, too.  It'd be tough, however, to argue that SRC's stock has not benefited from potential addition of the CCPT II assets.

I'll caution that the CCPT II / SRC merger is yet complete and not scheduled to finalize until early in the third quarter.  Things can change in a short period, but today it looks like Cole waived a fee it would have earned.

Private Equty Keeps Buying Homes

The housing rebound continues.  This morning Case-Shiller (via Calculated Risk) released its most recent three month average (December, January and February) that showed a 9.3% gain over the year earlier period.   Private equity keeps investing in single family homes.  Part of the reason is that despite recent gains, housing prices (Case-Shiller Composite 20 Index) are still 27.5% below their peak prices.  Here is a Bloomberg article from a week ago on funds raising billions of dollars to buy single family rental homes. These purchases will help keep inventory low and put upward pressure on prices. 

The Promises And Problems Of Non-Depleting Energy

Over the weekend I read a fascinating article from The Atlantic on energy.  The article, written by Charles C. Mann,  is titled "What If We Never Run Out Of Oil," and is a must-read.  The article is so full of important information that I'd end up reprinting the entire article if I tried to pull out the best points.  Mann puts oil and natural gas into their historic, global and geopolitical context, and details what new, expanded sources of petroleum mean to the world, which at times is optimistic and frightening.  The good news / bad news scenario of finding new energy sources repeats itself on a variety of areas, including environmental and economic issues.   Energy, and its source, will impact either directly or tangentially the future as much, if not more, than any factor.

Errors and Generalizations

I don't know what to make of Seeking Alpha.  Some of its article seem well researched, but others just make me shake my head.  This article from a week ago on the non-traded REIT industry has me discounting everything on Seeking Alpha.  I am not going to fisk the entire article, but it had way too many errors and generalizations for me to take seriously as either opinion or research.

The first paragraph jumps right in with generalizations and bad information:

Many of these currently non-traded companies will either list, or merge with listed REITs and those who have a head start on the analysis will be positioned to take advantage. There were 2 examples of such activity in very recent REIT history that show the importance of knowing about these non-traded REITs: American Realty Capital Properties' (ARCP) purchase of ARCT3 and Spirit Realty's (SRC) acquisition of CCPT2. In both cases, the mergers proved successful and the stocks have performed exceptionally well as a result.

Many "currently non-traded companies will either, list or merge with listed REITs."  Really? When?  The mergers and listings of non-traded REITs has been sporadic over an extended period, and it's dangerous to extrapolate AR Capital's recent liquidity activity to the entire non-traded REIT market.  Second, the Spirit / Cole Credit Property Trust II (CCPT II) merger is not even complete.  Spirit's stock has had strong performance since the REIT's announced merger with CCPT II, but the deal won't be complete until the third quarter.

The article's author says to look for a non-traded REIT that defers all its front-end fees for two years:

Consider avoiding companies which take their fees upfront. When only $0.90 out of every dollar gets invested, it can be very difficult to get above water. I will illustrate this concept by example.

Two companies, A and B each charge 10% distributed between salaries, commissions and fees. Company A structures their compensation upfront, while company B defers the charges for 2 years. Imagine that each company has a very strong acquisition pipeline such that they can invest at a 10% cap rate.

Company A takes its fee and invests 90% of the initial capital which is worth around 109% after 2 years. Company B invests 100% of the initial capital which is worth 121% after 2 years at which point it takes its fee leaving 111% for the investors. Despite taking a fee of precisely equal magnitude and the companies making the same caliber of acquisitions, those who invested in the company with deferred fees made 22.2% more profit.

Guess what, the non-traded REIT that defers its fees for two years doesn't exist, has never existed and never will exist.  It's ridiculous and disingenuous to even speculate - let alone offer a comparison - about a product that has never existed.  Maybe the author should start a deferred load REIT.  He'll learn fast how much money can be raised when brokers find out they have to wait two years to get their commissions.

The author states unequivocally to avoid American Realty Capital Trust V because of a "resource allocation" problem:

The parent company, ARC, has a new offering out called ARCT 5. This, in my opinion, has terrible resource allocation. It is going back to the triple-net single tenant retail space, but not opportunistically. In addition to the smaller spreads, it creates an active competition for properties between it and ARCP which are run by the same management team. Competing against itself and getting diminished margins is not desirable resource allocation.

What?  American Realty Capital Trust V (ARCT V) just opened and is starting to raise capital.  It has no meaningful "resources," so it can't have a resource allocation problem.  The article presents no data so substantiate the "smaller spreads" statement.  The "smaller spread" comment impacts all net lease REITs, so if the author believes his comments he should be selling all net lease REITs, not just a REIT that has no meaningful assets.  Both AR Capital and Cole have stated (through their affiliated REITs) in recent public filings that they are finding net lease investment opportunities at cap rates well above 7%.

The author stated that he went to the REISA conference last week - and probably suffered through multiple mindless panels - so I suspect he had to write something to justify his trip.   He should have stuck to some basic facts rather than make bold, but groundless and erroneous pronouncements.  But I guess no one would want to read that blog post.

Inland American Sells Office Tower

I have a bunch of articles to link to and comment upon where appropriate. Here is a Bloomberg article on Inland American selling a Minneapolis office tower, the tallest building in Minnesota, for $253 million.  The REIT bought the 57-story building in 2006 for $277 million.  I'm not sure of the original acquisition timing, but I'd guess Inland American bought this property sometime after it received a huge equity inflow resulting, in part, from the mostly cash sale of one of its non-traded REITs to Developers Diversified. 

Be Careful Of This Sale-Leaseback

I saw this Bloomberg article last week in the wake of JC Penney's recent management upheaval.  Apparently, one scheme Penney is considering to raise capital is to sell off its real estate and then lease it back.  Sale-leasebacks can be great deals for both sellers (they get upfront cash) and buyers (they get long-term lease income).  In the case of Penney, if it does execute this strategy, someone better look closely at the creditworthiness of whatever entity is responsible for the leases.  I'd be curious to know the location of the underlying properties, too, as I suspect Penney's in more than a few downtrodden malls.

Mind The Time Gap

Cole Credit Property Trust III (CCPT III) made a filing Friday announcing that its board of directors voted to suspend its dividend reinvestment plan and share redemption plan.  CCPT III will pay all its dividends in cash going forward, a typical decision for a non-traded REIT as it prepares for a listing.  Elimination of share redemption plans is typical, too, for non-traded REITs preparing for a listing, but timing of the elimination varies.  Cole Credit Property Trust II (CCPT II) suspended its share redemption plan in December 2012, more than a month before its announced merger with Spirit Realty, and more than six months before the merger is expected to close.  Another non-traded REIT, American Realty Capital Trust (ARCT), suspended its share repurchase plan on February 15, 2012, just two weeks prior to its March 1, 2012, listing.

If CCPT III's June listing goes as planned, investors should be without liquidity for less than three months.  (CCPT III, according to its 2012 10-K, redeemed all $28 million of shares requested in 2013's first quarter.)  But there is a twist to the CCPT III suspension that wasn't not present in either CCPT II or ARCT.  While investors, have to wait until CCPT III's June listing for anymore liquidity, Cole Holdings didn't have to wait for part of its payment, as CCPT III paid Cole Holdings the $20 million cash portion of its purchase price earlier last week. 

Casting Caution Aside and Craving Junk

Here is a Bloomberg article from yesterday on growing investor demand for the "riskiest, hardest to trade junk bonds."  Here are the points from the article that stood out to me:

More than four years after the worst financial crisis since the Great Depression, investors are casting aside fears of credit losses as they search for returns. With the Fed holding interest rates between zero and 0.25 percent for a fifth year, junk-bond yields plummeted to a record 6.35 percent yesterday, according to Bank of America Merrill Lynch index data.

The lowest-tier of dollar-denominated speculative-grade bonds are outperforming the highest-rated notes by 3.5 percentage points this year as investors funnel cash into debt with bigger cushions from losses when U.S. Treasury yields rise.

“The market is increasingly willing to accept less of a premium for both age and size,” said Eric Gross, a Barclays credit strategist in New York.

Chips Off The Table

American Realty Capital Properties (ARCP) withdrew its offer for Cole Credit Property Trust III (CCPT III) this morning.  I can't say that I am surprised by the announcement in light of CCPT III completing the acquisition of its sponsor, Cole Holdings, late last week.  In thinking about this transaction-that-wasn't, I'm of the opinion that both companies achieved a short-term victory.  CCPT III was able to fend off the mean "bully" Nicholas Schorsch and ARCP, while Mr. Schorsch was able to adroitly position himself as a CCPT III shareholder advocate.  More importantly, he has shrewdly set benchmark prices for a major competitor; prices that investors, independent broker / dealers and competitors will look to when the combined CCPT III / Cole Holdings lists as Cole Real Estate Investments (CREI) later in the quarter.  How CREI's stock trades relative to the ARCP-set hurdles of $12.50 per share and $13.59 per share - forget the $10.00 per share investors paid for their shares - is the new determinant of success, and the line - either over or under - which Cole or ARCP can claim victory.  While one phase of this saga is over, the epilogue is unfinished.

Timber's Rebound

Increasing demand and low supply, which has benefited a variety of real estate asset classes, has now moved to timber.   Lumber prices are approaching housing bubble prices, and Calculated Risk has insight:

Demand for lumber is increasing, but demand is still far below the levels during the housing bubble. However supply is lower than during the bubble years too. There are several factors impacting supply including a large number of sawmills still idled (it takes time to restart), the impact of the Mountain pine beetle, reduced maximum cuts in parts of Canada, and the permanent closure of high cost mills.

This price increase is before home builders really start construction to meet housing demand.  I plan to follow timber prices as home building returns to historic levels.   Here is a Calculated Risk graph of lumber prices going back to 2004:

I can think of a beleaguered non-traded REIT sponsor that could use some good news, and tangible positive results, for its timber REIT.

Look Out For New JC Penny Coupons

JC Penny has fired CEO Ron Johnson, known for his success with Apple Stores.  His tenure at JC Penney will likely go down as one of the biggest business flops of recent years.  I wonder, if given more time, he'd have been able to turn the company around.  Here is a short, prescient New Yorker column on his travails.  The article ends with this passage:

He’s (Johnson) become a living example of one of Warren Buffett’s keenest observations: “When a manager with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.”

Your Daily Letter Of Awesomeness

Have you had enough of Cole Credit Property Trust III's and American Realty Capital Properties' back-and-forth?  Well then, I direct your attention to the latest filing from TNP Strategic Retail Properties.  It is a letter from the non-traded REIT's board of directors to investors providing an update on the REIT and correcting - point-by-point - a letter sent to investors in late March from the REIT's current co-CEO, Anthony Thompson; a letter which was not approved by the REIT's board of directors.    Among other items, the board's letter corrects the amount of debt outstanding and total purchase price of the REIT's portfolio, use of sale proceeds and why the REIT didn't pay a first quarter distribution - surprise, it wasn't because the directors' fees were too high. 

$12.50 and $13.59

The ink wasn't even dry on the press release announcing that Cole Credit Property Trust III (CCPT III) had rejected American Realty Capital Properties' (ARCP) latest $13.59 per share buyout offer when CCPT III proclaimed that it had completed the purchase of its sponsor, Cole Holdings.  Here is a Bloomberg article on the purchase.  The speed of the completion tells me the outcome was fait accompli - CCPT III was intent on buying its sponsor regardless of any outside offer, whether from ARCP or any other company.  CCPT III's Special Committee really was special - for Cole Holdings.

This morning, Chris Cole, 100% owner of Cole Holdings, is $20 million in cash richer.  He also pocketed 10,711,225 shares of CCPT III stock, and gets another 2,142,245 shares of CCPT III stock when CCPT III lists it shares.  At $10.00 per share, the price paid for their shares by CCPT III investors, this totals nearly $150 million.  (And don't forget all the additional compensation - including a $7.5 million upfront cash bonus as part Mr. Cole's new employment package,  a potential Subordinated Incentive Listing Fee (at a benevolent 25% discount) if the new Cole Real Estate Investments, Inc. trades above $10.45, and a future, potential "earn out" in 2017, all of which could push the price CCPT III paid for Cole Holdings much higher then $150 million.)  

If I have learned one thing over the years it's that the only thing a rich guy wants is more money.   When a rich guys feels entitled to a big payday and sees big wad of investor cash that can make a payday happen, the avarice is compounded.   

While Chris Cole's $20 million Friday is easy to determine and tangible, the outcome for investors this morning is less certain.  ARCP's last offer for CCPT III was either $12.50 per share in cash, or shares in ARCP with a value of $13.59 per share for CCPT III investors.   CCPT III's Special Committee rejected this offer as insufficient, among other reasons.  Cole, to date, has offered no price assurance to investors upon the listing of Cole Real Estate Investments.  It now has its lofty price points - $12.50 per share and $13.59 per share - and they are known by every investor, broker, broker / dealer and Cole competitor. 

Thrice Spurned

Cole Credit Property Trust III has rejected American Realty Capital Properties latest buyout offer.  InvestmentNews has the latest news on the rejection.

Chesapeake And Board Independence

Spending so much time reviewing non-traded REITs, I am always skeptical about the role and power of independent directors.  I'm of the opinion that strong personality CEOs dictate most non-traded REIT business, with independent directors rubber-stamping management decisions.   Independent director acquiescence to strong-willed executives is not limited to non-traded REITs, not by a long shot. 

Last year I linked to articles and commented on public energy company Chesapeake and its now former CEO, Aubrey McClendon.  McClendon left Chesapeake March 31, but not before a final act of board fealty:

McClendon, 53, agreed in January to resign no later than April 1 after a shareholder revolt by Carl Icahn and Southeastern Asset Management Inc.’s O. Mason Hawkins cost the CEO his annual bonus and the chairmanship last year. A board inquiry into McClendon’s use of personal stakes in company-owned wells to obtain more than $800 million in private loans cleared him of any intentional wrongdoing in February.  (Emphasis added)

Apparently, the SEC didn't buy the board's internal whitewash investigation and is increasing its investigation into Chesapeake and McClendon.

Apartment and Mall Vacancy

Calculated Risk has posted updates from Reis on mall and apartment vacancies.  The occupancy rates at malls improved in the first quarter.  There was no information on rents, but new construction is at all-time lows, which points to continued improving vacancy rates.

Apartment vacancy rates dropped to 4.3%.  This is down from 2009's peak vacancy of 8.0%.  Apartment vacancies have recovered from the Great Recession faster than other commercial real estate property types.  New supply is still limited, but this is changing, and 100,000 new apartment units are anticipated later this year.  Reis discusses apartment rents:

Asking and effective rents both grew by 0.5% during the first quarter. This is the slowest rate of growth for both asking and effective rents since the fourth quarter of 2011; every single quarterly data point in 2012 showed stronger asking and effective rent growth versus what was observed in the current quarter. What does this mean?

Optimists will point out that the first quarter tends to be weak, as most households move during the second and third quarters and bolster leasing activity and rent increases. The seasonal waxing and waning in rent growth was evident in the prior year, when the strongest periods centered around the second and third quarters.

However, given how tight vacancies have become, rent growth ought to be stronger (for perspective, in prior periods when vacancies were in the low to mid‐4s, annual rent growth was well above 4%). Analysts have wondered how rents could keep climbing when jobs are being created at a sluggish rate and wage growth has been relatively stagnant: all of Reis's major markets now boast rent levels well beyond peaks achieved prior to the recession. One answer is that the moribund housing market left households with little choice but to absorb rent hikes, but with the housing market now recovering, does that mean the tide is turning against landlords?

The next few quarters will test the robustness of apartment fundamentals in the face of rising supply growth and rent levels that may have climbed to unsustainable levels.

Black Swan Prediction Fail

Here is a CNBC article via finance.yahoo.com attempting to predict potential Black Swans that will torpedo investment markets.  There is only one problem:  you can't predict a Black Swan, hence the name.  If you could predict a Black Swan, it's not a Black Swan.

Two of the predictions - Housing Bubble 2.0 and the Recovery That Isn't - don't even make sense.   The economic recovery is real - it's time to discuss another topic.  The Housing Bubble 2.0 is nonsense.  Home prices, nationally, bottomed a year ago, and prices have increased 10.2% over the past year.  Here is the key point that makes bubble talk silly:  home prices are still 26% below their peak.  The housing recovery is just getting started and it will pull the economy along with it.  Talk to me when home prices are 30% above their previous peak.

The only one of the three points I agree with is Risky Business, but not as a potential Black Swan.  Low rates are driving investors into buying risky investments in an attempt to capture yield.  Some of these investments aren't going to perform as anticipated.  This isn't a Black Swan event, it's common sense.  High yield investments are high yield for a reason.

ARCP and CCPT III Back and Forth

If you haven't already, it's worth reading the two most recent correspondences between American Realty Capital Properties (ARCP) and Cole Credit Property Trust III (CCPT III).  Note the tone in both letters:

ARCP Letter to CCPT III's Special Committee

CCPT III Response Press Release

ARCP, in its letter, revised last week's revised proposal, and is now offering cash of $12.50 per share for up to 60% of CCPT III's outstanding shares. 

Office Vacancy Update

Here is the latest Reis data on office rents and vacancy, via Calculated Risk.  In the first quarter, vacancy improved by a small amount, dropping to 17.0% from 17.1%.  Rents increased .7% in the first quarter, the tenth consecutive quarterly increase.  Rents are still nearly 8% below their early second quarter 2008 peak.  New construction is at record lows, and is expected to stay low until vacancy rates fall further. 

The Other Cole Merger

Cole Credit Property Trust II (CCPT II) and Spirit Realty Capital (Spirit) filed their joint proxy / prospectus this morning.  I am not going to read all several hundred pages, but I did read that the merger is still on track for a third quarter close and the initial ratio of .525 shares of Spirit stock for each share of CCPT II share is still in place.  Spirit's stock closed yesterday at $18.99 per share and this morning is back over $19.00 per share.  For those keeping score, Spirit stock needs to trade at or above $19.04 per share for a CCPT II investor to receive their original $10.00 per share CCPT II investment.  Spirit's stock has traded above $19.04 for the majority of the time since the merger announcement in late January.  CCPT II raised $2.3 billion in investor equity and had total assets of $3.29 billion at December 31, 2012.