Wednesday, September 10, 2014

Yuck Factor

Here is a Bloomberg article from last week on a unit of insurance giant AIG that is suing a life settlement company.  Life settlements are are described in the article:
In such deals, called life settlements, an investor buys insurance policies from individuals and pays the premiums until they die, when the investor collects the payout. The arrangement becomes less profitable for the investor the longer the person survives.
The division of AIG, Lavastone, hired a life settlement company, Coventry, to buy life insurance policies on its behalf.  The AIG unit is suing Coventry because it bought the life insurance policies cheaper than it knew AIG would pay for the policies and then sold the policies to AIG at a mark-up.

Let's look at this closer:  An insurance company, AIG, forms a division to buy life insurance policies cheap so it won't have to pay the full face amount of the insurance policy when the insured person dies.   "Let's pay $.20 now so we don't have to pay $1.00 later."   AIG had no moral problem buying insurance policies from old or sick people at deep discounts to avoid having to pay the full face value of the insurance, but it gets mad and sues when it found out it paid a deep discount plus a little more. The article didn't state whether Coventry was tasked to buy just AIG policies or could buy any available insurance policies, but I'm sure AIG wanted Coventry to buy AIG policies.  Either way, I don't have much sympathy for AIG.

Life settlement is not a pretty business.

Friday Hijinks

Strategic Storage Trust announced big changes Friday afternoon, September 5, 2014.   It changed its name to SmartStop Self Storage, Inc. and became self managed. As part of the self-management process, SmartStop, through its operating partnership, acquired the operating assets of Strategic Storage Holdings, LLC (SSH), which is the sole member in several affiliated entities.  SmartStop is not, apparently, acquiring its sponsor, Strategic Capital Holdings.  Through SSH, SmartStop expects to receive advisory and property management revenue from the advisors to two REITs in the early stages of their capital raising period, Strategic Storage Growth Trust, Inc. and Strategic Storage Trust II, Inc.

SmartStop acquired SSH's assets for $18 million in cash plus 773,395 units of limited partnership in the REIT's operating partnership.  If the REIT's current $10.81 per share value estimate is used, this puts the SmartStop's cost to acquire the affiliates at $18,000,000 in cash plus $8,360,400 (773,395 units times $10.81), or $26,360,400.  The 773,397 units earn the $.70 per share dividend, or $541,378 per year.  SmartStop had $23.7 million of cash on its balance sheet at June 30, 2014, and the $18 million represents big portion of that reserve. 

In addition, as part of the self-management process, SmartStop granted operating partnership units and Class B operating partnership units to the former advisors of several Strategic Storage entities. The total amount of operating partnership units and Class B units was 1,624,134, which at $10.81 per share is an additional $17,556,889.    The Class B units don't earn distributions until converted to operating partnership units if SmartStop's stock price reaches certain thresholds.  All the operating partnership units earn SmartStop's $.70 per share distribution, which is worth $554,911 per year.

The annual distributions on the newly granted shares total almost $1.1 million per year, a nice yearly stipend. 

SmartStop's letter to investors - which, of course, didn't disclose the price the REIT paid for SSH's assets, you need to go to a filing to find this information - states that the transaction is accretive to the REIT's earnings.  Excellent, I would hope so.  The way SmartStop has historically overpaid its distribution it needs an accretive acquisition.  Seriously, this accretion must be based, in large part, on sales projections and related fee earning potential for the two new REITs.  Both REITs are off to slow equity raises, so I suspect the equity raise projections are more aggressive than actual historical results.   One of the two REITs is private, although it has filed an S-11 to go public, and the second is public, Strategic Storage Trust II.  Through August 2014, Strategic Storage Trust II  had only raised $9.5 million in equity since starting its offering in early January 2014, an inauspicious start.  To its credit, Strategic Storage Trust II did raise $5.5 million in August, its best month since it started its offering.  I don't know how much the private placement has raised.

In the September 5, 2014, investor letter, SmartStop said its two new REITs have $172 million of property under contract on which it can earn fees.  I'd caution that a property under contract is not the same as owning the property.  I know credit criteria has eased in recent years, but you'll still need some fancy financial engineering to buy $172 million of property with only $9 million of equity.  The two REITs need to close the transactions before SmartStop starts to earn fees related to the properties.

There is much about this deal I don't understand.   I am not clear on exactly what SmartStop bought and what it didn't buy.  I don't know the impact of buying operating assets compared to buying entities outright.  I am not sure whether SmartStop bought the SmartStop brand or just the rights to it, and if that is the same thing, or if owning the brand even has any value.  I do not know if worrying about whether SmartStop owns the brand is even a worry.  I do not know when the transaction becomes accretive.  I do know the REIT is now paying out an additional $1.1 million in distributions on all the operating partnership units it issued whether the transaction is immediately accretive or not, and, that after paying out $18 million in cash SmartStop has limited reserves to continue subsidizing its already overpaid distribution.  I am not sure how the value of the transaction was determined.  I am not sure how, if at all, the transaction will impact a liquidity event.  I do not know why I have not read about this deal in any financial press.

Investors were not asked to vote on this $44 million transaction, which doesn't shock me.  I am an optimist at heart, but the pit in my stomach grew as I wrote this post.

I have copied a section from SmartStop's 8-K filed on September 5, 2014, on what SmartStop is purchasing to see whether anyone can make more sense of it:
On September 4, 2014, SmartStop Self Storage, Inc. (formerly known as Strategic Storage Trust, Inc.) (the “Registrant”) and the Registrant’s operating partnership, SmartStop Self Storage Operating Partnership, L.P. (formerly known as Strategic Storage Operating Partnership, L.P.) (the “Operating Partnership”), entered into a series of transactions, agreements, and amendments to the Registrant’s existing agreements and arrangements (such agreements and amendments hereinafter referred to collectively as the “Self Administration and Investment Management Transaction”), with Strategic Storage Holdings, LLC (“SSH”) and the Registrant’s advisor, Strategic Storage Advisor, LLC (the “Advisor”), pursuant to which, effective as of August 31, 2014, the Registrant acquired the self storage advisory, asset management, property management and investment management businesses of SSH. SSH is the sole member of the Advisor and Strategic Storage Property Management, LLC (the “Property Manager”). The Advisor had been responsible for, among other things, managing the Registrant’s affairs on a day-to-day basis and identifying and making acquisitions and investments on the Registrant’s behalf. As a result of the Self Administration and Investment Management Transaction, the Registrant is now self-managed, succeeds to the advisory, asset management and property management arrangements with two additional REITs, Strategic Storage Trust II, Inc. (“SST2”) and Strategic Storage Growth Trust, Inc. (“SSGT”), and has the internal capability to originate, structure and manage additional investment products which would be sponsored by the Registrant.
SSH Contribution Agreement
On September 4, 2014, the Registrant and the Operating Partnership, as Contributee, and SSH, as Contributor, entered into a Contribution Agreement (the “SSH Contribution Agreement”) whereby, effective August 31, 2014, the Operating Partnership acquired substantially all of SSH’s operating assets, including (a) SSH’s 100% membership interests in (i) the Property Manager, (ii) Strategic Storage Opportunities, LLC (“SSO”), (iii) Strategic Storage Realty Group, LLC, the parent company of the advisor and property manager for SST2 and SSGT, respectively, and (iv) Strategic Capital Markets Group, LLC, which owns a 15% non-voting equity interest in Select Capital Corporation, the Registrant’s former dealer manager and the current dealer manager for SST2 and SSGT, (b) all equipment, furnishings, fixtures, computer equipment and certain other personal property as set forth in the SSH Contribution Agreement, (c) all intellectual property, goodwill, licenses and sublicenses granted and obtained with respect thereto (including all rights to the “SmartStop®” brand and “Strategic Storage” related trademarks), (d) all of SSH’s Software as defined in the SSH Contribution Agreement, (e) all of SSH’s processes, practices, procedures and workforce (including a fully integrated operations team of approximately 300 self storage and other professionals), and (f) certain other assets as set forth in the SSH Contribution Agreement, in exchange for $18 million in cash and 773,395 units of limited partnership in the Operating Partnership (“OP Units”).

Thursday, September 04, 2014

The Quiet Liquidity Event

Liquidity events for non-traded REITs have become so routine that Tuesday's announcement that Cole Corporate Income Trust (CCIT) is being acquired by Select Income REIT (SIR) seemed a non-event.  CCIT investors can choose to take $10.50 per share in cash or receive .36 shares of SIR stock for each CCIT share.  Neither the cash option or the stock option can exceed 60% of the total.  The merger values CCIT at $3 billion and is expected to close in early 2015.

The Wall Street Journal's article on the transaction is worth reading, and here is the Bloomberg article on the deal.  American Realty Capital Properties / Cole Capital's press release on the transaction notes that $.20 per share is being paid for incentive fees and transaction costs.  I like this disclosure, as many of these non-traded REITs' liquidity events involve fees to their sponsor firms.  I have not seen the incentive fees so clearly disclosed before and would like to see these listed on all future liquidity events.

Complacency is never good.  Non-traded REITs are long-term, illiquid investments, and liquidity events should not be viewed as a regular occurrence.  The market has favored liquidity events for a few years, but this has not always been the case, and markets can change fast.

Speaking of liquidity events, I was on vacation when the NorthStar Realty Finance (NRF) agreed to acquire Griffin-American Healthcare REIT II in a $4 billion transaction.  By the time I got back to work most of the news on the deal had been out for more than a week making any thoughts I had on the deal stale.  I am still watching for updates and will comment as appropriate.