New Non-Traded REIT Performance Indexes

Robert A Stanger and the Institute for Portfolio Alternatives (IPA) just released a comprehensive report tracking the performance of many non-traded REITs.  The two indexes are a Life Style REIT index that includes all the multi-share class non-traded REITs, and a NAV Index for REITs that publish NAVs on a daily or frequent basis.  The returns for both indexes were determined without sales loads and with distributions reinvested, with a start date of January 1, 2015.

Shock upon astonished shock, the two firms - one that consults (Stanger) to the non-traded REIT industry and one that is the trade and lobbying group (IPA) for the non-traded REIT industry - have developed two indexes that show non-traded REITs outperforming the big four publicly traded REIT indexes.  Ten percent offering costs be damned!

Snark aside, Stanger's methodology appears sound, but the data should be used as a guide not as gospel.  Stanger uses the REITs' published NAVs when available, or Net Investment per share, as described by NASD Rule 2340.  I am wary of sponsor approved NAVs, not that they are inherently inflated, but due to the gap between stated REIT NAVs and real market values when REITs list (which seems to show inherent inflated valuations).  For example, American Finance Trust (AFIN) and Colony Credit Real Estate ((CLNC) which along with certain Colony Capital assets is the two NorthStar Real Estate Income REITs) trade well far their last stated NAVs.  Guide not gospel.

The new indexes' total return figures also include REIT distributions.  I won't go into the impact of paying more in distributions than is generated from Funds from Operations, other than to say that REITs that over pay their distributions better have a corresponding offset that lowers NAV.   At some point, systemic distribution over payment will be corrected and reflected in a REIT's valuation.  Gospel not a guide.

This is good time to release an index of non-traded securities.  Public REITs had a bad year in 2018 due to a poor performing overall stock market and the impact of rising interest rates on REIT stock prices.  Non-traded REITs, while affected by rising rates, do not see an added market discount in their NAV calculations.  Markets are cyclical, so a rise in REIT stock prices can erase index under performance in a short period of time.  Guide not gospel. 

In the mean time, with the release of these new indexes, look out for the marketing blasts from Hartman, the sponsor of Hartman Short Term Properties XX, Inc., the top performing Lifestyle REIT over a three-year period.

That's A Lot Of X-Boxes

The Toys-R-Us bankruptcy cost $200 million in adviser fees, presumably paid to bankers and attorneys, according to the Financial Times.  The Financial Times does not like links to its articles, but you can and should Google-search for the FT's excellent series The Debt Machine. 

2019's First Turd

That did not take long.  After their big announcement in late 2018, EJF Capital and Skybridge Capital have parted ways on the private $3 billion Skybridge-EJF Opportunity Zone REIT.  EJF was to act as the sub-advisor to the REIT.  Skybridge gave distribution firms' concerns about EJF's lack of experience managing real estate funds as the excuse to dump EJF.  The DI Wire article does not mention a sub-advisor replacement.

Opportunity zone investing is going to attract capital, possibly big capital, and just because a firm is first to market is no reason to throw it money.  Private equity firms, or hedge fund investors like Skybridge Capital, are transactional investors.  They look for opportunities, invest, recapitalize (take out profits), stabilize (take management fees), and exit (take more profits and return investor capital).  Opportunity zone investing is a long-term process.  It will ten years to realize the full tax benefits of opportunity zone investing. 

It makes sense to look at multiple opportunity zone sponsors and managers before investing.  A long-term track record of successful development is crucial.  A sponsor's ability to commit to the investment is crucial, too.  The big real estate sponsors are bashed on a regular basis, but with opportunity zone investing, I am waiting to see deals, if any, from sponsors like Inland, Hines, Griffin, CNL, or Black Creek.  I know that not all their deals have worked out, but they know the space, have the investor relations infrastructure, and have been around for more than ten years.

Ripped Toughskins

Sears Holdings, which owns Sears and Kmart, announced today that it is closing all its stores.  After 126 years Sears is done.  This CNBC article has a good summary of Sears' decline.  I don't believe Sears' death was inevitable.  It did face tough competition from Walmart and Target and then Amazon, but Target and Walmart have not gone out of business due to Amazon.  Sears did not have the retail management expertise to face its rivals and shifting consumer tastes and buying patterns.  This passage from the CNBC article gets to the heart of what happened to Sears:

(Eddie) Lampert saw opportunity in both (Sears and Kmart). The former Goldman Sachs intern had wowed investors with his ability to turn around the auto parts store . Armed with his hedge fund ESL Investments and the confidence of a man nicknamed “the next Warren Buffet,” Lampert believed he could concoct a similar turnaround in Kmart and Sears. He believed he saw value where others didn’t.

Lampert bought Kmart out of bankruptcy through ESL and ultimately combined it with Sears, to create Sears Holdings Corporation.

But Lampert was battling a national decline in the department store industry, as shoppers abandoned the mall and favored casual over formal wear. Department stores accounted for 14.5 percent of all North American retail purchases in 1985 but only 4.3 percent last year, according to Neil Saunders, managing director of GlobalData Retail. Sears’ peers, like Bon-Ton and Mervyn’s, whittled away, while rivals like and poured money into their businesses to be among the ones left standing.

Walmart and Target proved relentless in their competition. The companies scaled quickly and poured money into private label brands, which were better in quality than those sold at Sears and Kmart.

As Sears’ competitors invested in its stores, Sears took a different approach. Lampert believed that a strong loyalty program and data made investing in stores and advertising optional, people familiar with the situation have said. Then, as Sears’ sales fell and its losses piled up, it no longer had a choice — investment fell out of reach.

Sears shrank its store-base, in a desperate attempt of to regain profitability. The stores that remained were in disarray, with outdated fixtures, dark lighting and piles of unwanted clothes. Sears lost relevancy and its customers’ loyalty.

I am not upset about Sears, but it is another example of private equity buying a retailer and then not having the retail skills to operate the business.  Confidence and access to capital are great, but they are not the same as retail expertise.  If you are a landlord and a private equity firm buys one of your retail tenants you better start reserving for the day that tenant stops paying rent.

Separately, and much cooler than Sears' closure, is this episode of the podcast 99% Invisible about Sears Roebuck selling complete home kits through the mail.  The Sears' homes included everything to build a home, all the way down to light and plumbing fixtures, along with complete instructions.  Sears may soon be gone, but some of its mail order homes and other buildings are still in use.

Energy Embargo

FS Energy and Power Fund announced in an 8-K today that it has decreased the price at which it it issues shares under its distribution reinvestment plan from $6.50 per share to $6.10 per share, or a drop of over 6%.  I view the prices at which business development companies (BDCs) issue shares as part of their distribution reinvestment plans as a proxies for their net asset values.  FS Energy and Power is an energy sector BDC, and is, apparently, facing the same industry-wide problems as other leveraged loan lenders, which I mentioned late last week. 

Another PE Example

Here is another example of a private equity firm buying, stripping, ruining, and closing a retail firm.  This Washington Post article describes Sun Capital's acquisition and management of Marsh Supermarkets, with a particular emphasis on how Sun Capital used bankruptcy to get out of meeting employee pension obligations.  These stories seem to write themselves: Wall Street bankers start a private equity firm and raise investment capital, buy a business they now nothing about and have no skills to run or improve, sell valuable assets, leverage remaining assets, declare bankruptcy and close business, all the while taking out big fees and salaries.  This is a lopsided ledger, but Sun Capital's investors got their money out, probably at some positive Internal Rate of Return, so Sun Capital can claim its investment in Marsh Supermarket a success to raise more money and inflict its management on another company.

Financial Times Article

Boy, my last post was in late September and titled Disappearing Sponsors.  I did not also mean disappearing blogger.  Well, I have not gone away yet, although the sales to many alternative investments have gone away.  I will be honest, though, I am thinking of more effective ways to express my thoughts on alternative investments.  This blog will be just one outlet.

The Financial Times does not like links to its website, but it has an article from December 30, 2018, on KKR, Franklin Square, and Blackstone GSO that is worth your time to find and read.  The point of the article is that KKR has initiated big write-downs on some of the loans in the Franklin Square Investment Corp BDC that were originated by Blackstone's GSO.  (This BDC, after its merger with Corporate Capital Trust, re-named itself FS-KKR Capital Corp and trades under the symbol FSK.)  The write-downs is not new news to anyone that watched the falling stock price of FSIC or the lowered NAVs of the FS Investments' non-traded BDCs.  What has caught the attention of analysts is KKR's ballooning of the watch list, which tripled in 2018, and now encompasses 28% of the portfolio.

It looks like the high yield and leveraged loan market is going to be a story in 2019.  The Financial Times has had some good recent articles on the issues facing the high yield market.  In the KKR article noted above, The Financial Times notes that, industry wide, 70% of the leverage loans being issued are "covenant-lite," which means the loans lack the strict controls that would allow creditors to seize assets of under performing loans.  This also means that the underlying business do not have to meet as strict an operating criteria as do loans with stronger covenants.  The saying that "it was all good until it wasn't" could be 2019's leveraged loan market mantra.