Tuesday, July 29, 2014

Gibberish With A Dash Of Wisdom

This InvestmentNews article from yesterday has me scratching my head.  It's an opinion piece, loose on facts.  The article is written by the manager of the Resource Real Estate Diversified Income Fund (RREDX), an interval fund that invests a portion of its assets in non-traded REITs.   I am going to address a few points from the article.

This sentence early in the article is an understatement:
The best type of liquidity event is when nontraded REIT investors tend to make a profit on their initial investment.
 Duh.  I'm not sure what I can add to this bit of brilliance.

This specious passage troubled me:
Most liquidations happened in one of three ways:
1) An IPO into the REIT public market
2) A sale to an affiliated publicly traded REIT
3) A sale to a REIT sponsor that is a publicly listed company
Very few non-traded REIT liquidity events involve an Initial Public Offering.  An IPO as part of a listing has a stigma attached to it and indicates a REIT is in financial difficulty.  Does anyone remember Inland Western, now Retail Properties of America's (RPAI) IPO and listing?  An IPO involves raising new equity capital - that is the IPO part - and the few non-traded REITs with IPOs attached have locked up existing shareholders.  This happened with the former Wells Timberland (now Catchmark Timber Trust (CTT)) and BlueRock Residential Growth (BRG). 

A listing of shares not involving an IPO is a more common liquidity event.  Examples include American Realty Capital Trust, American Realty Capital Healthcare Trust (HCT), American Realty New York REIT (NYRT), United Development Funding IV (UDF), Cole Credit Property Trust III (listed as Cole Real Estate Investments)), Wells REIT II (Columbia Property Trust (CXP)), and CB Richard Ellis (Chambers Street (CSG)). 

The second point, the sale of a non-traded REIT to an affiliate requires a listed affiliate, which only applies to a few sponsors.  American Realty Capital, through listed American Realty Capital Properties (ARCP), and WP Carey (WPC) have used this method.  NorthStar Realty Finance (NRF) has the potential to use this strategy, but it has not to date.  Inland has several listed REITs but has not used these traded companies to buy or merge with any other Inland non-traded REIT.

The third point, sale of a non-traded REIT to a listed REIT sponsor, is even more tenuous.  The only example that I can think of is ARCP buying Cole Real Estate Investments last fall.  If the rumored NRF acquisition of Griffin-American Healthcare REIT II ever happens, that would be the second example.  A non-sponsor listed REIT buying a non-traded REIT is more common.  Kite Realty (KRG) purchased Inland Diversified earlier this year and Spirit Realty (SRC) acquired Cole Credit Property Trust II in 2013.  Both acquisitions were positive for the buyers.  Inland sold its second REIT to Developers Diversified (DDR) back in the mid-2000s.  There have been several post-listing acquisitions for former non-traded REITs, too, with Realty Income (O) acquiring American Realty Capital Trust after it listed, and now American Realty Capital Healthcare Trust (HCT) is being acquired by Ventas (VTR). 

If you look at the logic behind point three, it becomes a mute point.  Buying a competitor's non-traded REIT makes that competitor look good by giving it an instant track record and liquidity.  It makes no sense for a sponsor to give this advantage to competitor.  Plus, sponsors make big money during the capital raise and investing period, not so much from managing invested assets.  From a sponsor perspective, it's a poor business decision to buy a fully invested company after this one-time, money making opportunity is gone.

I am sick and tired of the fear-mongering trope about rising interest rates.  This article speaks as if rates have already gone up and stocks have tanked.   The article states:
We have also seen a decrease in the valuation of many of the net lease publicly traded REITs, the asset type that represents approximately two-thirds of the nontraded REIT market, due to concerns about higher interest rates.
Whether or not this is an opinion piece, the statement is wrong.  Check the stock charts of O, SRC, WPC and ARCP.  With the exception of ARCP, all are at, or not far from, 52-week highs, and ARCP is trading strong.  Yields on the ten-year Treasury are below 2.50%, and are down about 50 basis points from the start of the year.  Yes, some day interest rates are going to increase, but it has not happened yet.    

I'll finish on a positive note.  The following statement alone is worth reading the article:
Instead, investors should be prepared to stay in non-traded REIT programs longer and focus on the attractiveness of the investment, rather than an early exit.
Non-traded REITs are long-term investments, not short-term flip vehicles.  Recent liquidity events have been positive for investors, sponsors, and brokers.  I hope it continues.  But any investor in a non-traded REIT should be prepared to hold their investment for the maximum time stated in the offering prospectus, if not longer.

Thursday, July 24, 2014

North Dakota Oil Boom

Here is a short article worth reading from the Fivethirtyeight blog.  It discusses the boom in North Dakota's oil production, primarily in the Bakken Shale formation.  Besides the two startling graphs imbedded in article, this passage stood out:
The issue isn’t whether North Dakota will run out of oil. There’s little doubt that the Bakken Shale, North Dakota’s main oil-producing reservoir, contains billions of barrels of crude. The question is about getting it out. A well’s production rate — how much oil it pumps in a given amount of time — falls quickly, and wells drilled into shale rock like the Bakken decline especially fast, as much as 70 percent in the first year. That means oil production is a treadmill: Companies have to keep drilling just to keep production flat. The more they produce, the more they have to drill to keep up.
The 70% first year decline is incredible.  To help some of the depletion, drillers, through technological advances, have increased well productivity.   Wells on line for at least a month produced 116 barrels a month in 2007, now produce over 500 barrels a month.  

Wednesday, July 23, 2014

Sloppy Work

Recently I read an article and investment report on two finance companies that pay sizable current distributions and interest, all of which are supported by accrued revenue.  Accrued revenue or accrued interest is not paid until an investment or loan matures.  For example, if a company makes a two-year, $1,000,000 preferred equity investment with a 12% accrued interest, in two years the company will receive back the $1,000,000 in principal and $240,000 of interest.  There is a lag before a company realizes accrued revenue. 

If a company is paying a current distribution that is backed by accrued revenue, cash has to come from somewhere until the accrued revenue is realized.  This typically is either through borrowing or equity.  Eventually, as a finance company grows and matures, its flow of realized accrued investments should exceed the amount it pays in distributions. 

This is not yet the full situation in the two finance companies where 100% of their investments are accrued, and their current distributions are being paid through reserves, equity, borrowings, and in one company, some operating cash flow (realized accrued income).  Neither the article nor the investment report noted the accrued income, the time differential between when revenue is booked and when cash is realized, or addressed how the companies were paying current distributions.  This annoys me and it is sloppy work.   I believe the authors did not fully understood the companies they were writing about, which is bad.

There is nothing wrong whatsoever with finance companies that originate or own accrued investments.  If a finance company makes accrued investments with equity or borrowings that require current distributions or interest payments, how the company supports those current distributions or interest payments is important information.  Unfortunately, you would not get this information from the two pieces I read.

Monday, July 21, 2014

Filling A Void

I noted at the end of a post last week that Griffn-American Healthcare REIT II's shareholders are being solicited by a mini-tender firm.  The firm is offering to buy shares at a strong price compared to the REIT's original offer price.  Griffn-American REIT II is not the only non-traded REIT where shareholders are being approached by the mini-tender firms.  Signature Office REIT, the formerly named Wells Core Office REIT, and Strategic Storage Trust are also being targeted by mini-tender firms.  Below is a table with the offer price, tender price, and discount for the three tender offers:

Non-Traded REIT
Orig. Offer Price
Tender Offer
Discount to Offer
G-A Healthcare II
$10.00 to $10.22
0.0% to 2.2%
Strategic Storage Tr
$10.00 to $10.79
27.5% to 38.8%
Signature Off. REIT
All three of the non-traded REITs have terminated or suspended their share repurchase plans as they seek liquidity events, which have spurred the mini-tender firms.  These companies are annoying, to say the least, to non-traded REITs.  The mini-tender firms are money managers - not altruists - looking to acquire shares at cheap prices, not necessarily pay market prices, but they are stepping in to provide a limited form of liquidity where none is available.  The cliche is buyer beware, but in this case, it is seller beware.   

Friday, July 18, 2014

Liquidity Events and Hyperbole

I re-read the Bruce Kelly article I linked to earlier in the week.  The article stated that there were only two liquidity events in the first half of 2014.  Bruce missed a few.  Here are the liquidity events I know of in the first half of 2014:

Liquidity Events First Half of 2014
Fund Month Original Equity (Billions)
ARC Trust IV Jan  $1.7
CPA 16 Global Feb  $1.9
BlueRock Resid.* Feb  $- 
ARC Healthcare April  $1.7
ARC New York REIT April  $1.7
UDF IV June  $0.6
FSIC April  $3.0

In addition to ARC Healthcare and ARC New York REIT, the first half of 2014 saw ARC Trust IV complete its merger into American Realty Capital Properties (ARCP), CPA 16 merge into WP Carey, and the listings of Blue Rock Residential Growth* (BRG) and UDF IV (UDF).  I included the April listing of the first Franklin Square business development corporation, Franklin Square Investment Corp (FSIC), because while not a REIT it was a non-traded investment that provided a liquidity event. 

The strange part of the Kelly article was the Inland executive gloating about Inland Diversified's completed merger with Kite Realty:
The deal has been one of the most successful for nontraded REIT investors in the recent past, Mr. Sabshon said.

He noted that on July 2, the first full trading day for the Inland Diversified/Kite merger, Kite closed at $6.40. At an exchange rate of 1.7, that translates to an Inland Diversified exit value of $10.92, he said.

Excluding nontraded REITs that were purchased by related or affiliated REITs, a common industry practice, the Inland Diversified merger represents the highest nonaffiliated transaction exit price in two years, Mr. Sabshon said.
Yes, Inland Diversified's sale to Kite Realty was a successful liquidity event.  No, it was not the most successful listing of the past two years.  Does anyone remember the Cole Credit Property Trust III listing a year ago?  I believe there was some controversy surrounding this listing, but it opened at $11.50 per share.  The Inland executive's arbitrary exclusion of affiliated liquidity events makes no sense.  Is cash from an affiliated liquidity event worth less than cash from a non-affiliated liquidity event?  The CPA 16 and ARCT III liquidity events were with affiliated entities and traded at values higher than Inland Diversified's 9% premium.  I am taking nothing away from Inland Diversified's listing and its returns to investors, they are commendable and more than respectable, but let's lower the hyperbole. 

*  BlueRock Residential Growth (BRG) only raised about $23 million of investor equity in its multi-year offer period.  BRG's listing involved an IPO where the original investors received three classes of illiquid Class B shares.  The first B class does not convert to liquid shares until twelve months after the listing, and it'll be two years post-listing until original BRG shareholders are fully liquid.  BRG is a listing but should not be considered a liquidity event.   Its equity raise was so small it would not even show on the table above.

Thursday, July 17, 2014

Crap Storm Warning

This afternoon, Strategic Realty Trust disclosed in a SEC filing that it has determined a new net asset value (NAV) of $7.11 per share.  The REIT raised capital at $10.00 per share.  It issued valuation estimates during the offering period that reached $10.60 per share.  This $10.60 per share claim was as recent as early 2013 when it completed its offering period.  The new value represents a 33% decline in NAV in eighteen months, which was during a period of rising commercial real estate values.

This blog talked about Strategic Realty here, where it referenced an InvestmentNews article, and I talked about the REIT's valuation process here

This is ugly and someone is going to have to answer some tough questions. 

Starting To Make Sense

I wrote yesterday that I was not going to pay attention to any rumors until they showed up in a Bruce Kelly article.  No sooner than I had posted that comment than I read Kelly's report that NorthStar Realty Finance (NRF) is in talks to buy the Griffin-American Healthcare REIT II.  His story reads as though he sourced it through the same Financial Times article I referenced.  Kelly's article provides a good rundown of recent non-traded REIT liquidity events in addition to NorthStar's potential purchase of Griffin-American Healthcare REIT II.

At first I didn't understand why NRF would spend $3.7 billion to $4.0 billion for a healthcare REIT.  I immediately thought it was a way to combine the NorthStar and Griffin-American non-traded REIT sales platforms.  I have always primarily viewed NRF as a real estate finance company that, to a lesser extent, owned other real estate, including healthcare, manufactured homes and hotels.  Then I read NRF's first quarter 10-Q and the Griffin-American Healthcare REIT II acquisition makes more sense.  NRF hired James Flaherty III in January to build NRF's healthcare business.  From NRF's 10-Q:
In January 2014, NSAM entered into a long-term strategic partnership with James F. Flaherty III, former Chief Executive Officer of HCP, Inc., focused on expanding the Company’s healthcare business into a preeminent healthcare platform (“Healthcare Strategic Partnership”). In connection with the partnership, Mr. Flaherty will oversee and seek to grow both the Company’s healthcare real estate portfolio and the portfolio of NorthStar Healthcare. In addition, the partnership is expected to focus on raising institutional capital for funds expected to be managed by NSAM.
NSAM is the company NRF spun off earlier this month.  NSAM is NRF's asset manager and it or an affiliate will serve as the distributor and advisor for NRF's non-traded REIT business.   Mr. Flaherty is also the CEO and President of NorthStar Healthcare Income, Inc.  In May 2014, NRF acquired a $1.1 billion portfolio of healthcare properties, primarily assisted living and skilled nursing facilities.  NRF now has $1.63 billion of healthcare assets and is seeking to aggressively grow this business, and this explains NRF's interest in the  Griffin-American Healthcare REIT II portfolio.  NRF's first quarter 10-Q is worth a read because it discusses Mr. Flaherty's financial incentives to growth the healthcare business. 

How NRF would finance the Griffin-American Healthcare REIT II acquisition is another consideration, but the rationale for the purchase is clear.

Wednesday, July 16, 2014

LIBOR Plus ?!?!

When United Development Funding IV (UDF) listed on NASDAQ in early June it offered to repurchase up to $35 million of shares at a price of $20.50 per share.  The tender offer was oversubscribed by about three times, which was not unexpected.  UDF, in a filing last week, disclosed that it is financing the entire share repurchase with a $35 million loan from an entity called Waterfall Finance 4, LLC.  The loan has a one-year term and is due July 2, 2015.  UDF is paying LIBOR plus 9.0%, and interest is due monthly.  LIBOR is currently around .25%, so UDF is paying about 9.25% for the money.  I am snarkless.

Shut Up Already

The Financial Times published another apparent non-story last week.  (Sorry, no link to the story but you can Google it.) This one was on the alleged acquisition by NorthStar Realty Finance (NRF) of Griffin-American Healthcare REIT II at a price tag of $3.7 billion to $4.0 billion.  In late May the same FT reporter, Ed Hammond, had a story that Dividend Capital's Industrial Income Trust was looking to sell itself for $4 billion.  I discussed that article here

Nothing has happened yet with Industrial Income Trust, and a week and a half later I've read nothing else on a NRF / Griffin-American Healthcare REIT II combination.  In early May, Griffin-American Health REIT II was subject of a Wall Street Journal article on another impending sale that never happened.  I noted the WSJ article here.  I'm not sure what's going on with these rumors, but suspect they are attempts to drive up merger prices by attracting additional potential buyers.  From now on until Bruce Kelly reports a combination I'm not going to take any story seriously.

Based on data in the May Wall Street Journal article, a price of $3.7 billion to $4.0 billion for Griffin-American Healthcare REIT II would result in share price of $12.63 to $13.66.  If the merger leaks are an attempt to drive the price for Griffin-American higher, whoever is blabbing to reporters should stop.  A price per share range of $12.63 to $13.66 is excellent, especially since the REIT finished its equity raise less than a year ago at prices of $10.00 to $10.22 per share and paid a load of 12% on that equity. 

A NorthStar / Griffin-American Healthcare REIT II merger presents more narrative than was addressed in the short FT article.  Both Griffin and NorthStar operate respected syndication businesses.  Where do these play into the merger, if at all?  A combination of this business would be interesting and have more implications than just a single REIT's liquidity event.

Separately, but tangentially, Griffin-American Health REIT II shareholders are being solicited by mini-tender offers.  The companies that issue these tender offers usually make offers at deep discounts to prices paid by investors for their shares.  The current tender offer price for Griffin-American is $10.00 per share, essentially no discount to the price most investors paid for their shares.