WSJ, ADISA, and Woodbridge

I received an email from the trade group ADISA this morning that was mostly a reprint of its letter to the Wall Street Journal. The letter responds to the WSJ's May 7, 2018, article on the risks posed by private placements, with a particular focus on bad securities brokers.  The article used Woodbridge Group of Companies and the brokers that sold it as its examples.  The reporting is detailed, with its prime implication being that brokers that sell private placements are likely to have regulatory issues.  The ADISA letter states brokers that sell private placements are not bad.  The truth is likely somewhere in the middle.  

I wrote about Woodbridge last December, and included points that should serve as warnings to investors and brokers that are considering investing in or offering private placements.  I won't repeat them all, but in short, if an investment sounds too good - offering 8% one-year returns (Woodbridge debt investment example cited in the article) in a 1% investment environment - it is too good; or you are taking on so much risk the return should be at least double.  Think another way: why is a sponsor is willing to pay investors 8% when it should be able to borrow cheaper? Is that smart?  Maybe, but probably not. The answer is that the sponsor likely can't get a loan or other cheaper forms of capital, which is why it is offering such high interest rates.  And if the sponsor can't get cheaper financing, maybe the rate it is offering private placement investors is too low.  If a bank won't lend to a sponsor, neither should you. 

The WSJ article stated as fact that there were $710 billion in broker-sold private placements in 2017.  This is just staggering.  The private placements I see in the broker dealer world could not have totaled more than $10 billion in 2017, and that includes DST exchange products.  What are the other $700 billion in private, broker-sold investments?  Unfortunately, the biggest selling sponsor in the apparent tiny private placement world I see is one that offers products that pay investors an unsupported 8% distribution.

In today's or any day's investment environment there is no low risk way to earn 8% income from an investment.  This is true no matter what a broker says or a fancy brochure states. 

LVP - Least Valuable Player

I did not follow last year's merger of two non-traded REITs, MVP REIT I and and MVP REIT II, which raised a combined $165 million, but recent filings from the resulting REIT are worth a read.  Upon completion of the merger last fall, the new entity renamed itself The Parking REIT.  The merger is an example of a non-liquidity capital event, which are becoming all to familiar, but that is another post for another day.  In early April, the new REIT filed Form 12b-25, which is a notice of late filing.  The Parking REIT stated that it could not file its financial statements due to the following:

In February 2018, the Audit Committee of the Registrant's Board of Directors (the "Audit Committee") engaged independent legal counsel to conduct an internal investigation arising from the Audit Committee's receipt of allegations from an employee of MVP Realty Advisors, LLC, the Registrant's external advisor (the "Advisor"), regarding possible wrongdoing by the Registrant's Chairman and Chief Executive Officer, Michael V. Shustek, relating to (i) potentially inaccurate disclosures by MVP American Securities, the broker-dealer affiliated with the Advisor, to the Financial Industry Regulatory Authority, Inc. ("FINRA") relating to total underwriting compensation paid by the Advisor and its affiliates (other than the Registrant)  in connection with the initial public offerings of MVP REIT, Inc. and the Registrant and (ii) potential inaccuracies in personal financial statements of Mr. Shustek that were provided to one or more of the Registrant's lenders in connection with mortgage loans or guarantees where Mr. Shustek is a personal non-recourse carve-out guarantor.

The Audit Committee commenced the internal investigation and engaged independent legal counsel promptly upon becoming aware of the allegations. As a result of the pendency of the internal investigation, the Registrant is unable to finalize the Registrant's annual financial statements for the periods covered by the Annual Report.  While the investigation is ongoing, the Audit Committee has not found any irregularities in the Registrant's financial statements or accounting procedures, but no assurance can be given that such findings will not occur.

Just your normal financial chicanery.  On May 3, 2018, The Parking REIT's board's Audit Committee issued the results of its investigation.  I read the Audit Committee's findings as a confirmation of the allegations, but because of the REIT's plan to correct its past mistakes the board has been placated.  The REIT's broker dealer, MVP American Securities, amended its disclosures, and the REIT's Chairman and CEO Michael Shustek corrected the inaccuracies in his financial statements.  In addition the REIT agreed to hire a third party consultant to assess the REIT's internal controls, and the REIT will train employees on legal and regulatory obligations, and adopted the following Audit Committee recommendations:

o	Regularly evaluating the Board's composition for, among other things, independence;

o	Requiring the CFO to also report directly to the Board and to meet independently with the  Board at regularly scheduled meeting and on at least a quarterly basis; and

o	Assess and evaluate, at least on an annual basis, potential additional corporate  governance enhancements with the advice of outside legal counsel.

o	The Board declined to implement the Audit Committee's recommendation to bifurcate  the roles of Chairman and Chief Executive Officer, but agreed to further evaluate this  proposal for possible implementation in the future.

It is no shock that the board declined to limit Shustek's authority.  Board and Audit Committee member Allen Wolff resigned from the board, because his "philosophy and vision" are not aligned with the thinking of a majority of the board.  I am glad this REIT solved all its problems so fast and booted that pesky board member.  I can't think of any systemic financial or regulatory problems that a little training won't solve.

It does not take a genius to know that the wrong person resigned from this REIT and who is its LVP (Least Valuable Player).

Lack of Resource

Resource Realty has withdrawn its "innovative" office REIT.  The board of Resource Income Opportunity REIT voted to terminate the REIT's offering.  After a three-year offer period that included changing the REIT's structure to a perpetual life REIT, the board realized the REIT's investment premise stunk and that no broker wanted to sell it and no investor wanted to own it.  That the REIT only raised $2.1 million from investors over its extended offer period is a good indication of the market's low opinion of the REIT.  What a wasted effort.

C-III Capital Partners acquired Resource Realty's parent company, Resource America, in September 2016.  The expertise of C-III provided no sales boost to Income Opportunity, or to Resource's other investment funds.  After almost two years of C-III's tenure, Resource has had no new offerings, and its existing funds' capital inflows have been weak.  Through March, and after a two-year offer period, Resource's flagship apartment REIT, Resource Apartment REIT III, had only raised $45 million, which would include any sponsor contribution.  That is bad and looks like a "failure to launch" situation.  Resource's closed end funds' inflows are better, but not by much, and one, its interval fund, has seen redemptions since inception of 16.4% of capital received. The credit fund has raised $100 million net of redemptions in three years (bad), and the interval fund has raised $242 million net of redemtions in five years.  The interval fund, which was one of the first offered to broker dealers, is a distant third in terms of capital inflow behind the Griffin and Bluerock interval funds.

C-III needs to rethink its $200 million acquisition of Resource America. C-III either needs to create attractive products or shut down Resource's lame offerings all together, not that anyone would notice.  

Red Herring Soup

Yesterday's 8-K filing from Carter Validus Mission Critical REIT (CVMC) and today's DI Wire paraphrase of the filing omitted important information but added a nonsense red herring as a distraction.  Both the 8-K and article note that a major CVMC tenant, Bay Area Regional Medical Center, LLC, is filing for bankruptcy and is closing its facility on May 10, 2018, and the two state that CVMC is actively talking to the tenant and is pursuing all avenues to maximize shareholder value, including the sale of the property or its re-lease.  These are actions investors should expect from a sponsor.  Apart from Bay Area's bankruptcy and impending closure, Carter Validus's 8-K neglected to to discuss how the loss of Bay Area impacts the REIT.

According to CVMC's 2017 10-K released at the end of March, Bay Area's book value represented 20% of the REIT's year-end 2017 carried cost, and its lease revenue represented 21% of the REIT's contracted rental revenue.  Bay Area is the REIT's largest tenant by a wide margin, so its bankruptcy and immediate closure will have major financial repercussions for the REIT.  The next largest tenant, as measured by contracted rents, represented 12% of the REIT's contracted rental revenue, considerably less than Bay Area's 21%.  Because Bay Areas's departure rips a big hole in CVMC's revenue, what happens to CVMC's distribution, which was already lowered earlier this year?  How does Bay Area's bankruptcy effect not only the property's $86 million mortgage but the REIT's line of credit?  What happens to the REIT's NAV?  Dare I mention liquidity event timing?

CVMC's 8-K chose to avoid these questions and any disclosure beyond Bay Area's bankruptcy and plans to vacate its property, and opted for the irrelevant.  The 8-K touted Bay Area's market share and what other prominent medical groups it out performed.  DI Wire repeated this information and even added some news of its own, reporting on a Bay Area award and its trauma center's top certification.  None of this information is pertinent for a hospital that closes in two days.  As of Friday, Bay Area's market share will be a whopping 0%.  CVMC needs a trauma center, stat.

You can read the frivolity yourself; the entire two paragraphs of CVMC's 8-K is below:

On May 4, 2018, Bay Area Regional Medical Center, LLC ("Bay Area"), a tenant of Carter Validus Mission Critical REIT, Inc. (the "Company") through a wholly-owned subsidiary of the operating partnership of the Company, announced in a press release that it is closing its operations on May 10, 2018 and filing for bankruptcy in the near term. The Company is and has been actively communicating with Bay Area, and will seek all of its rights and remedies to enforce all obligations of the parties to the lease and any other agreements associated with the Company’s investment. The Company will seek to pursue all avenues to maximize stockholder value, which may include sale of the property or leasing of the building to a new tenant or tenants.

Based upon information provided recently by Bay Area, Bay Area Regional Medical Center’s Southeast Houston market share in the fourth quarter of 2017 was 12.61%, which ranked second to only one other single system, which was HCA’s Clear Lake Regional Hospital with a 36.59% market share.  According to Bay Area, Bay Area Regional Medical Center’s Southeast Houston market share outpaced Memorial Hermann Southeast Hospital, Houston Methodist’s St. John’s Hospital, and UT Medical Branch Hospital, all three of which are large systems in the Houston market.