Cornerstone Healthcare Plus REIT Pulls Offering, Hires Stanger
I love Friday afternoons.  I just saw this filing from Cornerstone Healthcare Plus REIT.  It has terminated its offering, and has hired Robert Stanger to assist it with its strategic alternatives.  One of the alternatives could include hiring a new managing broker / dealer, which would mean the REIT would reopen its offering at some future point.  Cornerstone Healthcare Plus began raising capital in August 2007 and has raised an anemic $130 million (approximately) in investor equity.   Here is the entire correspondence:

April 29, 2011

Dear Investor,

We are writing to inform you of a recent decision made by the Independent Directors Committee of the Board of Directors of Cornerstone Healthcare Plus REIT, Inc. (“CHP”). 

At the recommendation of our advisor, the Independent Directors Committee is considering various strategic alternatives for CHP to enhance stockholder value. One of the alternatives under consideration is the hiring of a new dealer manager for the company’s public offering of common stock.  The Independent Directors Committee has engaged Robert A. Stanger & Co. as its independent financial adviser to assist in the consideration of strategic alternatives.

In consideration of the uncertainty associated with these developments, our Independent Directors Committee has directed us to take the following steps with respect to our public offering.

The Public Offering.  Effective immediately, we are suspending our public offering.  Accordingly, we are not making or accepting offers to purchase shares of stock in CHP until further notice.

Suspension of the Distribution Reinvestment Plan.  Our offering included a distribution reinvestment plan under which our stockholders could elect to have all or a portion of their distributions reinvested in additional shares of our common stock.  Consistent with the above decision with respect to the offering, we are suspending our distribution reinvestment plan effective on May 10, 2011.  Therefore all distributions paid after that date will be in cash until further notice.

Suspension of the Stock Repurchase Program.  Our stock repurchase program provides stockholders with a limited ability to sell shares to us for cash until a secondary market develops for our shares.  Consistent with the decisions to suspend our public offering and distribution reinvestment plan, we are suspending repurchases under the program for reasons other than death effective May 29, 2011. We can make no assurances as to when or if repurchases will resume.  The share repurchase program may be amended, resumed, suspended again, or terminated at any time.

We believe that these steps will better position us to maximize stockholder returns over the long term.  We take your investment with us very seriously, and we look forward to continuing to serve you.

Sincerely,

Terry Roussel

President and CEO

The share repurchase programs are always the first casualties when REITs start exploring their "strategic alternatives."  Investors' limited liquidity options are now zero, except for trying to brave the secondary market.   Cornerstone Healtcare Plus has overpaid its distribution since inception, so now that the equity raise is over, I'll watch to see whether the current distribution level is maintained.

Thoughts On Behringer Harvard Multifamily's Recent Acquisitions
Over the past week Behringer Harvard Multifamily REIT I announced two investments.  The first is a 320-unit to-be-built apartment complex in Houston, TX.  The REIT will make a mezzanine loan investment in the development.   I am guessing the loan will accrue interest, which along with the principal, will convert to equity when the property's construction is complete and a permanent mortgage is obtained.

The second property is a 179-unit apartment complex, originally built in 2007 as condos, in downtown San Francisco.  The purchase price was $94 million, or $525,000 per unit.  Here is the 8-K filing.  Here is an article from a San Francisco real estate blog, Socketsite.   The comments are interesting, especially the one that says the cap rate was less than 4%, which is amazing if true. 

There was little financial detail provided in the two filings.  On the surface it appears the Houston investment will not generate meaningful cash flow in the immediate future, unless the mezzanine investment pays current interest rather than accrued interest.  The property's construction is slated for an early 2012 completion, and then it'll have a lease-up period that could take another twelve to eighteen months, so you looking at approximately two years before it is fully operational.  Absent financial data, the return on the San Francisco property is open for speculation. 

What is known is that at year-end 2010, Behringer Harvard Multifamily I's cash from operations and Funds From Operations (FFO) only comprised 5.5% and 15.9%, respectively, of its distributions, with the shortfall paid from offering proceeds.  The REIT closes its offering period at the end of July, meaning its largest source of distribution financing is ending.  While these two properites are only part of a now thirty-five property portfolio, I would have thought the REIT would show more urgency in its efforts to cover its distribution from property cash flow.

T Boone Pickens On Natural Gas Fracking
I heard most of this National Press Club panel interview with T Boone Pickens and Ted Turner while driving on Easter.   Pickens discusses the environmental issue surrounding natural gas fracking at around the 37:00 mark.

American Realty Capital Trust Modifies Its Share Grants
I just saw this press release announcing that American Realty Capital Trust has modified the compensation to its advisor by limiting the amount of shares it can grant to the advisor.  I will look at this in more detail, but on the surface this appears positive for investors.

Too Good To Be True?
I get plenty of junk emails, and I usually just delete them.  One caught my eye this morning.  Here is a partial reprint of the email, touting the product's highlights:

Product Features & Highlights:

 - Senior Secured Bonds for safety-
    these are NOT promissory notes !!

 - Interest rates:   6% for 1 year
                             7% for 2 years
                             9% for 3 years
                             12% for 5 years

 - Interest paid quarterly

 - BD Commission:  4.5% on 1 year bonds
                                       5.0% on 2 year bonds
                                       5.5% on 3 year bonds
                                       6.5% on 5 year bonds

Look, a CD equivalent!  6% for one year, and it pays a 4.5% commission that can probably be renewed every year.  Everybody's a winner!

Another Record
Last month this blog noted that Wells REIT II paid a near record price for a downtown Washington DC office property.  The Wall Street Journal reports that CB Richard Ellis REIT has paid a record price for a Jersey City property.  The REIT is paying $350 per square foot, and the return expectations are in the high 7% range, which, according to the Wall Street Journal article is a bargin compared to Manhattan real estate just across the Hudson River.  Here are some specifics from the article:

Hartz Mountain Industries Inc. this week sold twin 12-story office buildings in Jersey City’s Colgate Center in a deal that values them at about $310 million. That translates into a record $375 a square foot, according to Real Capital Analytics, a real-estate research firm.

The buyer, CB Richard Ellis Realty Trust, a nontraded REIT, is paying about $70 million and assuming $240 million in debt for the buildings at 70 and 90 Hudson St., which offer unobstructed views of Manhattan and are 100% leased.

Private Equity Real Estate
Bloomberg has a long, informative article on private equity real estate investment.  The article states that 439 private equity funds are looking for $160 billion in commitments.  That is a significant sum of capital.  The capital behind some of these private equity firms is staggering.  Firms like Blackstone have to make huge investments, like the $9.4 billion it paid to acquire Australia's Centro Properties' US mall portfolio earlier this year, and can't spend the time on individual properties.  The $9.4 billion in one transaction is more then four to six times what the typical non-traded REIT will raise in equity over two years.  (The article did not give specifics on the equity Blackstone used to acquire the Centro portfolio (I doubt it was $9.4 billion), but still, the comparative scale to non-traded REITs is impressive.)

New Tenant In Common Consolidation Venture
A new company, Ascent Realty Advisors, has been formed to help tenant in common investors and sponsors.  Here is an article from GlobeSt.com discussing the new venture.  The principals behind the new entity are from TIC Properties, a sponsor of tenant in common programs, and CapHarbor.  Ascent has formed a limited partnership, Ascent Commercial Property Limited Partnership, which will allow tenant in common investors (and presumably Delaware Statutory Trust (DST) investors as well) to exchange their interests for limited partnership units.  The exchange is called a 721 exchange and would allow TIC or DST investors to maintain their tax deferral while becoming part of a diversified portfolio.  The partnership will focus on office and industrial TIC and DST properties.  Ascent will likely form a public non-traded that will be affiliated with the partnership. 

Here is a quote from the GlobeSt article:

Ascent intends to allow for the roll-up of properties on a tax-deferred basis through section 721 of the IRS code. The company is also considering the formation of a publicly registered, non-traded REIT. The Ascent Fund, which will focus on office and industrial properties, will be managed by Ascent Commercial Property Management LLC, led by president Barry Gruebbel.

It is this blog's opinion that modifying the TIC or DST structure is going to be the only way many TIC or DST deals are going to be able to modify debt, short of selling the properites, and to get access to capital.   The above deal is the third that I have seen or heard about so far this year.   There are going to be more programs like this over the coming months.

More Fracking News
Here is an article from yesterday's New York Times.  It summarizes the finding of a Congressional investigation that was initiated last year when Democrats controlled the House.

Big Boy Pants
I have noticed over the past year or more that non-traded REITs are getting sophisticated in their financing, credit crisis notwithstanding.  Just last week it was announced that Wells REIT II raised $250 million in a bond offering (5.875% interest for seven years) and CNL Lifestyle REIT raised $400 million in a bond offering (7.25% interest for eight years).  The Wells REIT II bond offering is a rated bond, which is why its interest is lower than the rate on the CNL Lifestyle bond.  I am not aware of any non-traded REIT that had issued bonds before last week.

Last month this blog noted Health Care Trust of America's line of credit and its strict controls on distributions.  Other non-traded REITs are also obtaining lines of credits to facilitate acquiring properites and in some cases to help pay distributions.  (For without distributions, the REITs don't get equity flows, which means they won't be able to repay their lines of credit.  "We must borrow money to pay distributions, so we can raise money to repay the debt."  A classic Catch-22 if there ever was one!)

I understand that the lines of credit are being used to smooth cash flows and to facilitate acquisitions in advance of equity.  The Wells and CNL bond issues are a sign of maturity and may benefit these REITs in the long run by exposing them to the capital markets before their listings (although I am still trying to figure out how CNL Lifestyle benefits from a 7.25% interest rate).  The non-traded REITS are entering into sophisticated transactions that contain strict financial restrictions and require the REITs to operate within the debt covenants.  As an example of the level of complexity, the following passage is from CNL Lifestyle's indenture for its recent bond offering and details the restrictions, in mind-numbing legalese, on Lifestyle's distributions:

Section 4.07 Restricted Payments.

(a) The Company will not, and will not permit any of its Restricted Subsidiaries to, directly or indirectly:

(1) declare or pay any dividend or make any other payment or distribution on account of the Company’s or any of its Restricted Subsidiaries’ Equity Interests (including, without limitation, any payment in connection with any merger or consolidation involving the Company or any of its Restricted Subsidiaries) or to the direct or indirect holders of the Company’s or any of its Restricted Subsidiaries’ Equity Interests in their capacity as such (other than dividends or distributions payable in Equity Interests (other than Disqualified Stock) of the Company and other than dividends or distributions payable to the Company or a Restricted Subsidiary of the Company);

(2) purchase, redeem or otherwise acquire or retire for value (including, without limitation, in connection with any merger or consolidation involving the Company) any Equity Interests of the Company or any direct or indirect parent of the Company;

(3) make any payment on or with respect to, or purchase, redeem, defease or otherwise acquire or retire for value any Indebtedness of the Company or any Guarantor that is contractually subordinated to the Notes or to any Note Guarantee (excluding any intercompany Indebtedness between or among the Company and any of its Restricted Subsidiaries), except a payment of interest or principal at the Stated Maturity thereof; or

(4) make any Restricted Investment (all such payments and other actions set forth in these clauses (1) through (4) above being collectively referred to as “Restricted Payments”),

unless, at the time of and after giving effect to such Restricted Payment:

(1) no Default or Event of Default has occurred and is continuing or would occur as a consequence of such Restricted Payment;

(2) the Company would, at the time of such Restricted Payment and after giving pro forma effect thereto as if such Restricted Payment had been made at the beginning of the applicable four-quarter period, have been permitted to incur at least $1.00 of additional Indebtedness pursuant to the tests set forth in Section 4.09(a), 4.09(b) and 4.09(c) hereof; and

(3) such Restricted Payment, together with the aggregate amount of all other Restricted Payments made by the Company and its Restricted Subsidiaries since the date of this Indenture (excluding Restricted Payments permitted by clauses (2), (3), (4), (5), (6), (7), (8) and (9) of paragraph (b) of this Section 4.07), is less than the sum, without duplication, of:

(A) 95% of Funds From Operations of the Company for the period (taken as one accounting period) from January 1, 2011 to the end of the Company’s most recently ended fiscal quarter for which internal financial statements are available at the time of such Restricted Payment (or, if such Funds From Operations for such period is a deficit, less 100% of such deficit); plus

(B) 100% of the aggregate net cash proceeds received by the Company since the date of this Indenture as a contribution to its common equity capital or from the issue or sale of Qualifying Equity Interests of the Company or from an issuance of Qualifying Equity Interests of the Company pursuant to the DRP (it being understood that for the purposes of this clause (3)(B), with respect to any issuance pursuant to the DRP, the Company will be deemed to receive net cash proceeds equal to the amount of the cash dividend they otherwise would have paid in respect of such Equity Interests) or from the issue or sale of convertible or exchangeable Disqualified Stock of the Company or convertible or exchangeable debt securities of the Company, in each case that have been converted into or exchanged for Qualifying Equity Interests of the Company (other than Qualifying Equity Interests and convertible or exchangeable Disqualified Stock or debt securities sold to a Subsidiary of the Company); plus

(C) to the extent that any Restricted Investment that was made after the date of this Indenture is (a) sold for cash or otherwise cancelled, liquidated or repaid for cash, or (b) made in an entity that subsequently becomes a Restricted Subsidiary of the Company, the initial amount of such Restricted Investment (or, if less, the amount of cash received upon repayment or sale); plus

(D) to the extent that any Unrestricted Subsidiary of the Company designated as such after the date of this Indenture is redesignated as a Restricted Subsidiary after the date of this Indenture, the lesser of (i) the Fair Market Value of the Company’s Restricted Investment in such Subsidiary as of the date of such redesignation or (ii) such Fair Market Value as of the date on which such Subsidiary was originally designated as an Unrestricted Subsidiary after the date of this Indenture.

Notwithstanding the foregoing, the Company and any of its Restricted Subsidiaries may declare or pay any dividend or make any distribution or take other action (that would have otherwise been a Restricted Payment) that is necessary to maintain the Company’s status as a real estate investment trust under the Internal Revenue Code if (i) the aggregate principal amount of all outstanding Indebtedness of the Company and its Restricted Subsidiaries on a consolidated basis at such time is less than 60% of Adjusted Total Assets and (ii) no Default or Event of Default shall have occurred and be continuing.

This is a very complex agreement, with repeated references to defined terms located elsewhere in the indenture.  It's a document written by lawyers for lawyers.  The way my non-lawyer eyes read the above clause is that Lifestyle can continue paying its current distribution rate to investors, but if Lifestyle's leverage exceeds 60% of assets, than the restrictions kick-in.  The REIT's leverage was at 55% of assets at year-end 2010.

The point is not the above legal jungle, but that this jungle is complex and the once financially staid world of non-traded REITs has embraced a treacherous path.  I don't believe that REITs accessing sophisticated financing is bad, actually I think it's good.  Interest rates are still near historic lows and it makes sense to take advantage of the low rates, if done in a prudent manner.  But the REITs need to understand that the banks are not their friends.  These lines of credits and bonds have restrictive covenants that REIT managers (as well as the broker / dealers that sell these non-traded REITs) need to read and understand.  Investors, too, need easy-to-understand disclosure - i.e. "if our leverage ratio (amount of debt divided by total assets) exceeds 60%, we will have to cut the distribution we pay you."  Banks will pounce if the covenants are not obeyed and ignorance is not a defense.   Banks do not come out on the short end of too many deals.

The low interest rates on the lines of credit are enticing, and make acquisitions more attractive.  But buying a long-term asset with short-term debt that provides accentuated returns is seductive, but unsustainable.  I am seeing lines of credit being used to repay maturing debt.  Retiring debt with a line of credit without a plan to replace the line of credit with either equity of permanent mortgage debt is reckless.  If REIT advisors don't act to quickly match property debt with the property's expected hold period, the REITs could be caught in a squeeze if interest rates rise, or if equity raises fail to match short-term debt maturities.  I suspect I'll be writing multiple posts about debt covenants in the future.

ARC Snark
This press release from American Realty Capital Trust (ARCT) popped up on my Google News feed over the weekend.  Here is the important part of the press release:

With the pending July 25, 2011, close of ARCT’s initial public offering, the Company’s advisor, American Realty Capital Advisors, LLC, intends to initiate the process of interviewing investment banking firms and other advisory firms to provide its board of directors with recommendations in exploring various strategic actions to maximize shareholder value, including the assessment of various liquidity alternatives.

ARCT commenced its initial public offering on January 25, 2008, and as of the date of this press release has raised total gross proceeds of $885.2 million. As of the date of this press release, the Company has acquired 320 properties for a total purchase price of $1.27 billion, consistent with the Company’s investment strategy, i.e., acquiring free standing, single tenant properties net leased long-term to investment grade and credit worthy tenants.”

Let me guess what's going to happen.  ARCT will hire JP Morgan as its advisor, ARCT will announce a plan to list its shares sometime before the middle of 2014, once ARCT's a listed company, investor shares will convert to liquid shares on a deferred basis, probably over eighteen months, and for the next three months wild rumors about near-term liquidity and high per share valuations will spread.   This is the playbook from Healthcare Trust of America.   Like Healthcare Trust of America, it is important to watch the liquidity and vesting of the shares paid to management, to make sure management is not cashing out first.   Buying a non-traded REIT is a long-term investment, never an arbitrage play.

Retail Fails to Follow Office and Apartments
The commercial retail real estate vacancy rate increased to 9.1% in 2010's first quarter, highest level in ten years.  Here is info from Calculated Risk and a detailed Bloomberg article. 

Good Commercial Real Estate News
From yesterday's Calculated Risk, here is a post discussing the first drop in office vacancy rates since 2007.  Reis Inc's quarterly survey on office properties shows that the national vacancy rates at the end of the first quarter 2011 stood at 17.5%.  The decrease was only .1% from 2010's fourth quarter, but after the last four years I will take any positive move.   Below is a chart from the post showing quarterly vacancies since 1991:

Today Calculated Risk has a post on Ries' quarterly apartment report, which shows vacancies at a three year low.   The vacancy rate is 6.2%, down from 8% a year ago.  Much of the drop in vacancy has come from the elimination of concessions.  Here is Calculated Risk's analysis on the drop in vacancies:

This is a very large decline from the record vacancy rate set a year ago at 8%. This decline fits with the recent survey from the NMHC that showed lower apartment vacancies. Reis is just for large cities, but this decline in vacancy rates is happening just about everywhere.

A few key points we've been discussing:
• Vacancy rates are falling fast (the excess supply is being absorbed). Note: The excess housing supply includes both apartments and single family homes.

• A record low number of multi-family units will be completed this year (2011). Only 6,000 apartments came on the market in Q1 (in the Reis survey area).

• This will push up effective rents. Via Bloomberg:

Effective rents, or what tenants actually pay, increased in 75 of the 82 markets Reis tracks, to an average $991 a month from $967 a year earlier and $986 in the fourth quarter.

However, when I was at the NMHC conference earlier this year, it sounded like rent growth is mostly coming from reductions in concessions and not from the top line (i.e. not from rent increases). (my short notes from conference here and here). Still, any increase in effective rents will push down the price-to-rent ratio for homes.

• Multi-family starts are increasing, and that will help both GDP and employment growth this year. These new starts will not be completed until 2012 at the earliest, so vacancy rates will probably decline all year.

If You Can't Beat Them, Join Them - Part II
I received the following comment on my previous post:

I read the filing differently. First, looking closely at ARCT’s 10K, the entire award to management is 1.5 million shares ($15 million). Not sure how you are arriving at $75 million. Second, only half the award is time vested. The other half is purely performance based and is paid only after the investor receives 100% of his/her capital back plus a non-compounded annual 6% return on capital. Finally, no vesting occurs at all for two years, and the award vests over a five year period. My take is that the independent board made the stock award based on management’s exemplary performance to date. Seems to me there is a big difference between this type of award and an internalization fee which seeks to retain management, irrespective of performance. At the end of the day, ARCT’s restricted stock plan is pay for performance. It merely recognizes the results achieved.

American Realty Capital Trust (ARCT) initiated the restricted stock awards program in January 2010.  The initial amount available for restricted stock awards was 1% of the amount of shares being offered or 1,500,000 shares, which totaled $15,000,000.  In the post effective amendment filed on March 11, 2011, the amount appears to have been changed to reflect no more than 5% of the shares outstanding, up to a maximum of 7,500,000 shares or $75,00,000 if all ARCT shares in the offering are sold.  At February 28, 2011, the amount of shares outstanding was 74,854,000.  So, 5% of 74,854,000 is 3,742,700 shares available under the incentive restricted share plan, which at $10 per share is $37,437,000.  Obviously, the amount of shares outstanding, and therefore amount available under the incentive restricted share plan, will increase as more shares are sold and ARCT moves towards the close of its offering period.

It is hard for me not to correlate the dropping of internalization fees in June 2010 and the recent, potential five times increase in shares available under the incentive restricted share plan.

The incentive restricted shares are not immediately vested.  Half the shares are paid over a four year period.  Half the shares have a subordination feature.  The subordination feature is not like the one described in the comment above, although that would be excellent if it was.  The incentive (subordination) feature is follows:

50% vest only to the extent our net asset value plus the distributions paid to stockholders equals 106% of the original selling price of our common stock.

I think it is best to use an example to how these shares may vest.  The 106% of the original offering price is $10.60 per share, which is the amount by which the combined net asset value and cumulative distributions must exceed before ARCTs' incentive restricted shares are allowed to vest.

ARCT is required to make a net asset value calculation eighteen months after it closes its offering.  Assuming ARCT closes its offering on June 30, 2011, it would have to provide a net asset valuation by December 31, 2012.  For illustration purposes, I'll use a net asset value of $8.85 per share, which is just the offering price of $10.00 per share less ARCT's offering costs, which are competitive with other non-traded REITs.   It is probable that the net asset value will differ from this amount.   Next you need to add ARCT's cumulative distributions to the net asset value.  (I don't read anything in the description above that reflects the timing of distributions.)  ARCT paid a 6.7% distribution in 2009.  In 2010 it paid 6.7% for three months and 7.0% for nine months.  If it continues to pay a 7% distribution in 2011 and 2012, it will have paid cumulative distributions of $2.74 per share by the end of 2012.   If the cumulative distributions of $2.74 are added to the $8.85 net asset value, and this totals $11.59, which is greater than the $10.60 share price that triggers the vesting.  The following table uses the paid distributions and the $8.85 per share net asset value price estimation:

2009	$0.65
2010	$0.69
2011	$0.70
2012	$0.70
Cumulative Distribuiton	$2.74
NAV at 12/31/2012	$8.85
NAV + Distributions	$11.59

Finally, I'd want to address the exemplary management comment.  I want ARCT's management to be exemplary, and this post or the previous post are not disparaging ARCT.  The non-traded REIT industry needs ARCT's management to be exemplary.  But to me, I think it is too early to bestow awards for excellent management, whether for ARCT or any REIT still in its offering phase.  Olympic gold medals in the 100-meter dash are not awarded after twenty yards, the Lombardi Trophy is not awarded at the end of the first quarter, and I have never heard of a baseball owner giving a manager a performance bonus in the middle of May.  A non-traded REIT (or any investment product) should not award multi-million dollar, dilutive, stock grants, whether restricted or not, to management while the REIT is still in its offering phase and while it is still investing investor capital.

If You Can't Beat Them, Join Them
I was alerted in a comment to this blog that American Realty Capital Trust has awarded its executives shares of restricted stock.  Here is the wording from the post-effective amendment that American Realty Capital Trust filed on March 11, 2011:

On September 13, 2010, our advisor granted 934,159 restricted shares of common stock to Nicholas S. Schorsch, chief executive officer of our advisor, 212,370 restricted shares of common stock to William M. Kahane, president and chief operations officer of our advisor, 160,604 restricted shares of common stock to Peter M. Budko, executive vice president chief investment officer of our advisor, 55,270 restricted shares of common stock to Edward M. Weil, Jr., executive vice president and secretary of our advisor and 37,597 restricted shares of common stock to Brian S. Block, executive vice president and chief financial officer of our advisor. Fifty percent of the restricted shares vest over a four year period commencing with the one year anniversary of the September 13, 2010 grant date and 50% vest only to the extent our net asset value plus the distributions paid to stockholders equals 106% of the original selling price of our common stock.

On June 2, 2010, American Realty Capital Trust announced that it was waiving any internalization fees in the event that it internalizes its external advisor as part of of a sale or listing American Realty Capital Trust's shares on an exchange.  The awards above came about three months after the announced waiver of any internalization fees.   The pool of stock available to award is up to 7.5 million shares, which at $10 per share is $75 million.   In the quote above, at $10 per share, the awards last September are worth nearly $10 million to Nicholas Schorsch and over $2 million to William Kahane. The bulk of the shares that American Realty Capital Trust can allocate to its executives is still available for allocation.


Internalization fees can be lucrative to the external advisor, and some non-traded REITs have paid more than $100 million for their advisors.   American Realty Capital Trust's decision to waive internalization fees was positive for investors.

The company that distributes American Realty Capital Trust is Realty Capital, which also distributed Healthcare Trust of America (HTA).  HTA waived its internalization fees in 2009, but recently expanded its pool for executive and board member stock awards by $80 million.  It looks like American Realty Capital is following HTA's path.

Half of the American Realty Capital executive stock awards are deferred over four years and half vest only "to the extent our (American Realty Capital Trust) net asset value plus distributions paid to stockholders equals 106% of the original selling price of our common stock." 

To me, American Realty Capital's granting of large amounts of stock to its executives is another form of an internalization fee.  The large amount of stock was issued by American Realty Capital Trust after the announcement that there would be no big pay day when it purchased (internalized) its advisor, plus American Realty Capital has plenty more stock it can grant its executives.  Like HTA, American Realty Trust appears to have figured a way around its waived internalization payday.

The Return of Subprime Bonds
Here is a Wall Street Journal article on how pricing on subprime bonds has rebounded and how subprime bonds are attracting investors, including conservative insurance companies.  The focus of the article is on existing subprime bonds, which as an investment class, saw prices drop to near $.30 on the dollar at the worst of the credit crisis.  Subprime bonds are now trading near $.60 on the dollar.  The article's point is that subprime bonds' recent strength signifies a healing of the credit markets, as investors are willing to take on more risk.

The return of subprime bonds, according to the article, is also signaling that the housing market has bottomed and has more upside than downside.  The article focused on subprime bonds issued before the credit crisis.  It did not mention any new issues.  I'd be curious to know if there is any demand for new issue subprime bonds, or if there are even any new subprime mortgages that could be included in a new subprime bond issue.

One encouraging sign is the govenment's refusal to take the short end of an offer by bailed-out insurer AIG:

The market burst into the spotlight in March when an unlikely buyer stepped in: AIG, the giant insurer that had to be bailed out by the government because of its own bad bets on subprime mortgage bonds.

AIG offered to buy back a pool of bonds that the Federal Reserve had taken off its hands during the crisis. AIG's $15.7 billion offer for the bonds, which have a face value of $30 billion, spurred other investors to consider making offers.

Citing "improved conditions" in the market and "a high level of interest by investors," the Fed on Wednesday rejected AIG's offer and said it would begin selling off these mortgage holdings, letting investors bid for pools of bonds and individual securities so the central bank can maximize its profits.

At least four large life insurers, among the most conservative of all investors, are eyeing the subprime bonds the Fed plans to sell, according to people familiar with the matter.

Colony Capital Is Kicking Grubb & Ellis' Tires
Santa Monica-based private equity firm Colony Capital provided Grubb & Ellis an $18 million bridge loan, and received an exclusive sixty-day negotiating and evaluation period to determine whether it will make a larger "strategic investment" in Grubb.  If Colony makes a larger investment, Grubb then has twenty-five days to shop the deal around to try and get a better deal.

Here are two articles regarding the Colony loan, one from GlobeSt and the second from the Orange County Register's real estate blog.  Colony has been involved in multiple transactions over the past several years.  From the GlobeSt article:

The financing deal with Grubb & Ellis is the latest in a series of investments for Colony Capital, which has been involved in some of the largest FDIC deals to date and has been active on a number of other fronts. In 2009, for example, Colony launched a publicly traded REIT, Colony Financial, that focuses primarily on acquiring, originating and managing performing, sub-performing and non-performing commercial mortgage loans.

More recently, Colony led a consortium of investors in acquiring two FDIC loan portfolios with an unpaid balance of $817 million that include 1,505 residential and commercial acquisition, development and construction loans. In Los Angeles recently, funds managed by Colony Capital and R.W. Selby & Co. acquired a portfolio of seven student housing properties adjacent to the University of Southern California comprising 223 units and 836 beds from Westar Associates for $98 million.

In early 2010, investment vehicles managed by Colony paid $90.5 million for a 40% interest in an LLC created by the FDIC to hold assets of 22 failed-bank receiverships and became the managing equity owner of the LLC. Colony was one of 21 bidders who vied for the 40% ownership interest in the LLC, which owned a portfolio of approximately 1,200 distressed commercial real estate loans with an unpaid principal balance of $1.02 billion, of which 70% were delinquent.

Grubb did not waste much time finding a potential suitor, announcing only last week that it had hired an advisor.

Worth Reading... Closely
Healthcare Trust of America filed an 8-K today.  Here is the text of the entire filing:

On March 24, 2011, the board of directors of Healthcare Trust of America, Inc. ("HTA") authorized distributions for the month of April 2011. These distributions will be calculated based on stockholders of record each day during such month at a rate of $0.00198630 per share per day and will equal a daily amount that, if paid each day for a 365-day period, would equal a 7.25% annualized rate based on a share price of $10.00. These distributions will be paid in May 2011 in cash or reinvested in stock for those participating in HTA’s distribution reinvestment plan.

The amount of distributions HTA pays to its stockholders is determined by HTA’s board of directors, at its discretion, and is dependent on a number of factors, including funds available for the payment of distributions, HTA’s financial condition, capital expenditure requirements and annual distribution requirements needed to maintain HTA’s status as a REIT under the Internal Revenue Code, as well as any liquidity alternative HTA may pursue in the future. HTA’s board of directors may reduce its distribution rate and HTA cannot guarantee the amount of distributions paid in the future, if any.

Is it me, or is that second paragraph telling us something?

Disclosure v. Non-Disclosure
In my last post I discussed Healthcare Trust of America's failure to disclose restrictive covenants in an 8-K filing announcing a new line of credit.   As a comparison, I direct you to Wells Real Estate Investment Trust II, which recently announced a short-term bridge credit facility in an 8-K filing.  Like the HTA line of credit, the Wells REIT II credit facility has restrictive covenants regarding paying more in distributions than generated in Funds from Operations (FFO).  The restrictions are clearly disclosed in Wells REIT II's 8-K, and here is the language:

The JPMorgan Chase Bridge Facility agreement also stipulates that the Registrant's net distributions, which equal total dividends and other distributions less the amount reinvested through the Registrant's dividend reinvestment plan, may not exceed the greater of (i) 90% of the Registrant's Funds from Operations through the date of payment or 100% of the Registrant's Funds from Operations for the two most recently completed fiscal quarters; or (ii) the minimum amount required in order for the Registrant to maintain its status as a REIT. Funds from Operations, as defined by the agreement, means net income (loss), minus (or plus) gains (or losses) from debt restructuring, mark-to-market adjustments on interest rate swaps, and sales of property during such period, plus depreciation on real estate assets and amortization (other than amortization of deferred financing costs) for such period, all after adjustments for unconsolidated partnerships and joint ventures. With limited exceptions, the Registrant may not make net distributions if a default or an event of default has occurred and is continuing or would result from the payment of net distributions.

The covenants like those in the Wells REIT II and HTA credit agreements are not uncommon.  My point is not the restrictions, it is that HTA should have disclosed the restrictions in its 8-K.

HTA's 10-K
Healthcare Trust of America filed its 10-K annual report sometime on Friday.  It is nearly 200 pages long, and there is a substantial amount of data to read and analyze.  I recommend reading it carefully if you have an interest in the REIT.  It is going to take me several days to get through it and write coherent posts on the items I feel are important.   I could not get past the section in the 10-K that discussed the credit agreement (Note 9 of the 10-K, starting on page 138) HTA entered into in November 2010 with JP Morgan and other banks.  This section appears very important to me, especially as it pertains to HTA's ability to maintain its current distribution rate.

Before you read the 10-K, I recommend you read the 8-K HTA filed on November 23, 2010.   This 8-K announced a $275 million line of credit with JP Morgan and others, and talks about basic terms of the line such as term, interest rate calculations and fees. The 8-K did not disclose the credit line's restrictive covenants, which include the language below: 

Pursuant to the credit agreement, beginning with the quarter ending September 30, 2011, our operating partnership may not make distribution payments to us in excess of the greater of: (i) 100% of its normalized adjusted FFO (as defined in the credit agreement) for the period of four quarters ending September 30, 2011 and December 31, 2011, (ii) 95% of normalized adjusted FFO for the period of four quarters ending March 31, 2012 and (iii) 90% of normalized adjusted FFO for the period of four quarters ending June 30, 2012 and thereafter.

This language was in the credit line agreement that was an exhibit to the 8-K, so I guess the restriction was technically disclosed.  The way I read the credit agreement, the restrictive covenants are effective on HTA whether or not the credit line is drawn.  At year-end the credit line had $7 million outstanding and in a subsequent event (after December 31), HTA repaid the $7 million.

As stated in the 10-K, in 2010 HTA generated $69.4 million in FFO and paid out $116.8 in distributions, or stated another way, distributions were 168% of FFO.  This is well above the 100% covenant listed above.  In 2010's fourth quarter, HTA generated $13.5 million of FFO and paid $33.3 million in distributions, or 246% of FFO.  HTA, as disclosed in the 10-K, has maintained its current distribution rate of 7.25% through April.  My understanding of the dividend covenant above, leads me to believe that at some point before the end of September 2011, HTA is going to have to cut its distribution so that for the four quarters ending September 30, 2011, the combined distributions will not have exceed 100% of FFO.  The only way to avoid a distribution cut is for HTA's FFO to substantially to exceed its current distribution rate for the next two quarters, or if the credit line is canceled.

This restriction on distributions should have been disclosed to investors and broker / dealers in the November 23, 2010 8-K, rather than been buried in the actual credit agreement.  HTA's shareholders are mostly small investors looking for income, not institutions with staff and attorneys to review each document. 

There are other issues in the 10-K that I will address, including the possible elimination of the share repurchase plan, which was sharply restricted last fall, compensation to HTA's executives and directors, including discuss of HTA's CEO Scott Peters taking partial stock awards in cash, rather than shares, at $10 per share (while limiting investor share redemptions), along with presenting financial data.  If you see any gems in the document, post them in the comment section.

Washington DC Stays Strong
Tishman Speyer Properties is buying a suburban Washington DC office building for approximately $500 a square foot, one of the highest prices ever paid for a suburban Washington DC property.  The seller was Beacon Properties, which just sold a downtown Washington DC property to Wells Real Estate Investment Trust II.  I could not find any cap rate disclosure on the Tishman Speyer transaction.  The acquisition helps confirm that the Washington DC commercial real estate market is one of the strongest in the country.

Cole Bets On Phoenix
Cole Properties made news last year when it paid $310 million for a Seattle-area property subject to long-term lease to Microsoft.  I was told today to expect another large Cole acquisition that was big enough for inclusion in tomorrow's Wall Street Journal.   I am guessing Cole's $170 million sale-leaseback of for-profit college Apollo Group's headquarters in Phoenix is the news.  Here is an excerpt from a Wall Street Journal / Dow Jones article:

According to a securities filing, Apollo agreed to sell its headquarters to a unit of Cole Real Estate Investments, a non-traded real estate investment trust based in Phoenix. Apollo then will lease the properties back at an annual rental rate of $12 million, with 2% increases each subsequent year. Apollo expects $28 million in gains on the sale, to be realized throughout the life of the lease. The lease, with an initial term of 20 years, has four five-year renewal options. 

The cap rate is 7% based on the $170 million price tag and $12 million of rent, assuming the lease is triple net.  The acquisition of the 600,000 square foot complex is Cole's largest property in Phoenix.

The article states that Cole plans to make $3 billion worth of acquisition in 2011, up $500 from 2010.

More Grubb & Ellis
Here is a more comprehensive CoStar article on Grubb & Ellis and how its decision to "explore strategic alternatives" is part of bigger changes in the commercial brokerage industry.  The article does not present any new information on Grubb & Ellis, restating the story from the articles I linked to yesterday.  It does put Grubb's decision into context:

"The Grubb & Ellis announcement is part of a natural evolution in the industry where firms in the middle market with revenues between $100 million and $1 billion will really have to either get much, much bigger, or much smaller," said Dylan Taylor, chief executive officer in the U.S. for Colliers International. "Mid-market firms are strategically challenged. They may not be big enough to be multi-billion-dollar global players that can afford to invest in recruitment of talent and technology."

The article goes on to discuss recent commercial brokerage transactions.  This statement on the global push of commercial real estate stuck out to me:

Some of the expanding firms may be international firms looking to enter or grow their presence in the U.S. For example, London-based Savills recently announced it was reviving its U.S. expansion, opening two new offices and forming an international investment group. In February, CBRE agreed to acquire ING Real Estate Investment Management, a unit of Holland-based ING Group NV.

Any article on Grubb & Ellis always mentions the portfolio of tenant in common transactions and the CoStar article does not disappoint:

Although the company has a wide U.S. footprint for delivering transaction and management services, one of the challenges facing Grubb & Ellis is that it also has a large portfolio of troubled tenant-in-common (TIC) assets acquired when Grubb joined with NNN Realty Advisors Inc. in 2007 near the peak of the real estate boom. The company has faced complicated integration issues during the downturn, including management of the NNN Realty legacy assets.

In February, Grubb launched Daymark Realty Advisors Inc. as a wholly owned and separately managed company to manage those assets. Daymark becomes the fourth Grubb & Ellis reporting segment in addition to its transaction, management and investment management businesses. It also becomes one of the nation's largest asset management companies, overseeing a nationwide portfolio of about 33 million square feet, including more than 8,700 multifamily units.

The TIC assets, which ironically gave NNN Realty Advisors the scale to acquire Grubb & Ellis, are now viewed as an albatross to Grubb & Ellis, which I think is a short-sighted view.   But my opinion on the old TIC assets is a topic for a future post.

Grubb & Ellis Exploring "Strategic Alternatives"
Here is an article from GlobeSt.com discussing Grubb & Ellis' (GBE) decision to explore strategic alternatives, including a sale or merger.  The article is mostly an excerpt from a Grubb & Ellis press release.  Grubb & Ellis, in addition to its commercial brokerage business, sponsors the Grubb & Ellis Healthcare REIT II, a non-traded REIT.

Update:  Here is a better article on Grubb from The Orange County Register's real estate blog.

Why The Deficit Will Never Go Away
Politics.  Politicians of both parties need to repay the special interests that helped elect them, and the special interests don't like losing their government perks paid for by taxpayers.  Here is an example from Econobrowser on the House's refusal to tackle $15 billion in annual farm subsidies, which sums up the dilemma when deficit cutting rhetoric meets political reality:

But the Agriculture Committee is dominated by members of Congress from farm states; Chairman Frank Lucas, R-Okla., has reported $445,714 in political contributions from the agricultural industry during the course of his career, and ranking Democrat Collin Peterson of Minnesota reports $809,097 in career donations.

MFFO - It's Not You, It's Me
Modified Funds From Operations (MFFO) is a performance metric used to measure a real estate investment trust's financial health.  I do not like the metric and discount it when looking at a REIT's financial performance.  To me, MFFO adds back too many one-time items to make it useful for analyzing the long-term financial status of a REIT.  Non-traded REIT sponsors like to use MFFO when discussing a REIT's ability to cover its distribution because MFFO is going to be a higher number than operating cash flow or Fund From Operations, making the REIT's performance appear better.  When analyzing a REIT's ability to fund its distribution from cash flow I prefer the old fashioned method of comparing actual operating cash flow and Funds From Operations to a REIT's distributions, because I believe MFFO may inflate a REIT's coverage ratio. 

Funds from Operations (FFO) takes a REIT's net operating income and adds back non-cash accounting entries like depreciation.  It also includes an adjustment for property sales.  This leaves you with a pretty good estimation of a REIT's cash available for distribution.  Modified Funds From Operations takes FFO and then adds or subtracts other one time items, in particular acquisition expenses.  A REIT in its capital raising stage will have significant acquisition expense additions, skewing MFFO upward.  Neither FFO or MFFO are GAAP (Generally Accepted Accounting Principals) figures, only operating cash flow is a GAAP figure.  Because MFFO is a non-GAAP calculation, I always check the footnotes to see what items were added back to MFFO.

If a REIT purchases a significant number of properites late in the year the MFFO to actual cash will be even greater, as all acquisition expenses are added to MFFO while actual cash received is small.  Here is a simple example of a property acquired for $50 million.  I assumed the acquisition expenses are 3.50%, and a cap rate of 7%, which all goes to cash flow.  If the purchase closed on December 1, here is what the flow of funds would be:

Purchase Price	$50,000,000
Acq Cost %	3.50%
Acq Cost	$1,750,000
Addition to MFFO	$1,750,000
Cap Rate	7%
Annualized NOI	$3,500,000
One Month NOI	$291,667
Actual Cash	$291,667

The REIT would receive $291,667 in cash from the property, but would be able to add an additional $1,750,000 to its MFFO.  Even though the MFFO looks great, only the $291,667 is available for distribution.  Bear this in mind as non-traded REITs release their 2010 results in the coming weeks and tout their levels of MFFO. 

If you must look at MFFO, beware of the above and look for an improving trend, i.e. more MFFO covered by actual cash over multiple periods.  The disparity between operating cash flow, FFO and MFFO should narrow over time.  Wide differences in an established REITs operating cash flow, FFO and MFFO, when compared to the REIT's distribution, may signify that the current distribution is not sustainable.  For REITs early in their life cycle the divergence is going to be large but watching the trend is vital.  Chronic overpayment of distributions, while good for marketing, is bad and untenable long-term.  A trend where FFO and operating cash are getting closer to MFFO is positive. 

I have looked at enough financial statements over the years to know that it is not a good sign when distributions exceed operating cash flow for extended periods.  Many people in the broker / dealer and real estate industries have worked hard to make MFFO a more consistent and relevant figure, and I applaud them.  But for me, I will stick to my old fashioned method of comparing operating cash flow and FFO to distributions, it has rarely steered me wrong.

Healthcare Trust of America's $80 Million Non-Internalization Fee
Healthcare Trust of America (HTA) closed its offering period on February 28, 2011.  A mere two days after the offering period closed, on March 2, 2011, HTA filed an 8-K that announced major changes to its original 2006 Incentive Plan for executives and directors.  HTA's board increased by five times the number of shares that can be granted to executives and board members from 2,000,000 shares to 10,000,000 shares.  At $10 per share the increase is worth $80,000,000.  The 8-K states:

The plan is designed to provide maximum flexibility to our Board and Compensation Committee in designing individual awards. 

Cha-Ching!  I take this as HTA's board's intention to pay themselves and HTA's executives as much as possible.  It looks to me like any stock awards under the plan have favorable vesting for HTA's board members and executives, as detailed in the 8-K filing:

Unless otherwise provided in an award certificate or any special plan document governing an award, upon the occurrence of a change in control of the company (as defined in the Amended and Restated 2006 Plan) in which awards are not assumed by the surviving entity or otherwise equitably converted or substituted in connection with the change in control in a manner approved by the Compensation Committee or our Board: (i) all outstanding options and stock appreciation rights will become fully vested and exercisable; (ii) all time-based vesting restrictions on outstanding awards will lapse as of the date of termination; and (iii) the payout level under outstanding performance-based awards will be determined and deemed to have been earned as of the effective date of the change in control based upon an assumed achievement of all relevant performance goals at the "target" level, and the awards will payout on a pro rata basis, based on the time within the performance period that has elapsed prior to the change in control. With respect to awards assumed by the surviving entity or otherwise equitably converted or substituted in connection with a change in control, if within one year after the effective date of the change in control, a participant’s employment is terminated without cause or the participant resigns for good reason (as such terms are defined in the Amended and Restated 2006 Plan), then: (i) all of that participant’s outstanding options and stock appreciation rights will become fully vested and exercisable; (ii) all time-based vesting restrictions on that participant’s outstanding awards will lapse as of the date of termination; and (iii) the payout level under all of that participant’s performance-based awards that were outstanding immediately prior to effective time of the change in control will be determined and deemed to have been earned as of the date of termination based upon an assumed achievement of all relevant performance goals at the "target" level, and the awards will payout on a pro rata basis, based on the time within the performance period that has elapsed prior to the date of termination.

HTA's board has not yet awarded the $80 million in new stock, it has just increased the amount of stock it can award.  In reading the above legalese, HTA's board has seen all the recent health care mergers and has positioned the board and executives for a big payday in the event of an HTA merger or acquisition.

The HTA message board at ReitWrecks has a serious take-down of the increase in shares available under the Incentive Plan.  I agree with ReitWrecks that the large increase of stock in the Incentive Plan is HTA's attempt to pay itself the internalization fee it waived in 2009 when it became self managed.  Here is what HTA said one year ago in its 2009 annual report stressing the benefits to investors of its plan to become self-managed:

No Internalization Fees.  Unlike many other non-listed REITs that internalize or pay to acquire various management functions and personnel, such as advisory and asset management functions, from their sponsor or advisor prior to listing on a national securities exchange for substantial fees, we will not be required to pay such fees under self-management.  We believe that by not paying such fees, as well as by operating more cost-effectively under self-management, we will save a substantial amount of money for the benefit of our stockholders.  To the extent that our management and board of directors determine that utilizing third party service providers for certain services is more cost effective that performing such services internally, we will pay for these services based on negotiated terms and conditions consistent with the current marketplace for such services on an as-needed basis.

I guess it seemed like a good (marketing) idea at the time to forego the internalization fees.  HTA's executives seem to have figured a way to recoup the big internalization payday that was waived less than two years ago.  HTA's board conveniently waited until after it finished its capital raising period to disclose the changed Incentive Plan.  An internalization would have required a shareholder approval, and however distasteful the internalization price tag, at least it would have been put to a shareholder vote.  This new, potential $80 million change to the Incentive Plan was not put to an investor vote.  HTA's board unilaterally made the decision to boost the Incentive Plan.  Investors had no say in this enormous potential payday to management.  HTA's ploy is a sucker punch to investors and the broker / dealers that sold HTA.

The 8-K ends ominously for investors:

Based on their ongoing review of our current compensation structure, our Compensation Committee and Board of Directors are actively involved in the process of assessing various changes to our compensation programs, which include without limitation, the review of key employment agreements and the discussion and negotiation of changes to such agreements. It is anticipated that changes to our compensation programs will be implemented in the future, consistent with, among other things (1) our current strategic initiatives and achievements and (2) the actual level of employee performance successfully undertaken to date and the expected level of performance in the future in order to achieve these initiatives.

HTA's board is giving notice that it's set to bestow on HTA's management another big payday - including salary boosts, bonuses and stock awards under the Incentive Plan - just like it did last year.  I noted the egregious increase in HTA management pay here.  Sucker punch number two should be announced in HTA's 10-K, which should be released within the next two weeks.

HTA is owned by the shareholders, not HTA executives or the board.  If HTA has any independent board members they need to earn their outsized pay and look after investors' interests.  Broker / dealers, HTA is mocking you, and you should not stand for it.

Allaying Municipal Bond Fears
Here is an informative post on a Roubini bond research report.  It's a good read and discusses the historical perspective of muni bond defaults and presents the legalities that states face if they try to re-work bonds.

Update:  Roger Lowenstein has an article on municipal problems.  I don't feel as good now.  But this point early in the article makes Meridith Whitney's dire default scenairo seem overstated:

These and other struggling locales do not begin to approach Whitney’s forecast of hundreds of billions in municipal defaults this year. (It would take defaults by 40 cities with as much debt as Detroit to reach even $100 billion.) Some industry experts accuse Whitney of exaggerating the crisis and of worsening the cities’ problems by frightening away investors. Whitney’s theory is that states, whose finances are also in desperate shape, will cut off local aid to preserve their own budgets; cities that have been subsisting on government transfers would become fiscal orphans and, in a financial sense, unworkable. She has not elaborated on her thesis beyond a few well-chosen television appearances. (She declined to talk to me.) But in the two months following Whitney’s warning, investors unloaded about $25 billion in shares of mutual funds that invest in municipal bonds. The selling spree sent the prices of these munis, typically among the most reliable investments, into a free fall.

A Whole Fracking Series
I referenced a New York Times article earlier in the week on natural gas drilling and the process of hydrofracking and its environmental impact.  The article is one in a series of three on the issue.  Here is a link to the entire series.

What?
This Bloomberg headline is as strange as it is incomprehensible:

Marijuana-Like High Helps Ex-Trashman's Syn Battle Solid Sex

Why Senior Housing
Wednesday's Wall Street Journal article on senior housing was complex.  It was one of those articles that you read quickly, realizing that a second or third more comprehensive reading is required, and one that I usually don't go back to re-read despite my best intentions.  Here is a CoStar article that says many of the same points, but is easier to understand.  The key driver is a 2008 REIT tax law change that allows health care REITs to by senior housing operating companies and not lose their REIT tax status.  Senior housing is as much a business as it is real estate so REITs' ability to buy operating entities is a significant change.  Here are two key paragraphs that summarize my thoughts from earlier in the week and the tax changes:

Senior care facilities suffered more pain than other health-care properties during the recession as older Americans postponed decisions to move into retirement housing. The sector also endured uncertainty in 2008 and 2009 over the future of government health care legislation and reduced Medicare and Medicaid reimbursements. As baby boomers begin to enter retirement and the population of 85+ -year-old Americans grows, cash-flush real estate investment trusts have scrambled to acquire a diminishing supply of available seniors housing, assisted-living and post-acute facilities.

These factors, combined with a change in REIT tax law that allows health care REITs to own third-party operators to manage and collect income from their facilities similar to hotels, have helped fuel a number of large transactions in recent months, including the two huge deals announced on Monday. As CoStar Group reported last week, . industry executives predict more mergers and acquisitions between both public and private companies.

The senior housing decision is an economic decision.  Growth in senior housing demand is a positive sign for the economy, and it will have more impact than the repositioning due to tax law changes.

The Apartment Disconnect
The Wall Street Journal's Development's blog notes the same problem with apartments that I've noticed.  Defaults keep rising on apartment CMBS debt, but apartments still command price premiums due to their perceived safety.  Apartments have the highest CMBS default, at 16.6%, topping even lodging's 14.6%, and the apartment default rate is much higher than the CMBS default rate of 9.4%.  I have seen plenty of large apartment investment funds over the past several years that have ranged from bad to scary.  I have seen two interesting private placement deals that are buying below the radar (i.e. small) multifamily deals.

Wells REIT II - Channeling Joe Biden
To paraphrase the vice president, it's a big freaking deal. Wells REIT II made two filings today, one not unexpected and another that just jumped off the page.  Wells REIT II announced that it was cutting its dividend from 6% to 5%.  The REIT had been telegraphing this for sometime, disclosing in at least its last two 10-Qs that its distribution was not fully covered by operational cash flow and the board was monitoring whether the REIT could maintain the dividend.  Wells REIT II follows the trend of non-traded REITs - Hines REIT, Inland American to name two - that dropped distributions after closing their offering period.  While the drop in distribution is unfortunate, it was not unexpected, and appears prudent. 

Wells REIT II also announced a huge acquisition.  The REIT is paying $615 million for Market Square, a 679,710 square foot, Class A office complex in Washington DC.  This equates to $905 per square foot.  This monster transaction should represent at least 10% of Wells REIT II's portfolio.  I am not sure whether it's comparable, but another downtown DC office property recently sold for $596 per square foot.  If the sale is comparable, REIT II did not get the property on the cheap.  Wells REIT II's purchase of Market Square is not going to tamper the opinion that Washington DC is the hottest commercial real estate market in the country.  It was a big freaking deal.

My Two Cents on Two Health Care Mergers
I noted two health care mergers yesterday.  It appears that both deals were driven by senior housing, which includes skilled nursing facilities.  There are a couple of forces behind the focus on these types of health care properites.  Many senior housing and skilled nursing facilities qualify for government agency debt, which means the leverage can be higher (70% to 80% debt) and the interest rate lower than traditional financing.  Medical office buildings do not qualify for the agency debt and have debt options that require more equity, leaving leverage ratios typically between 45% to 55%.  It appears that health care companies are giving premiums to property types that can utilize attractive financing.

The focus on senior housing is also a bullish sign for the economy.  Much of senior housing is elective.   When seniors and families decide it's better for an elder person to live in an assisted living facility, compared to moving in with families or staying alone, it's an expensive decision and long-term financial commitment.  (Obviously, skilled nursing and memory care facilities are less optional.) Financing aside, the demand by buyers of senior housing tells me these buyers believe that demand for senior housing will increase.

Yet Another Health Care Merger
The third largest health care REIT, Health Care REIT, Inc, agreed to acquire privately owned Genesis HeatlhCare, a leading provider of senior care and senior rehabilitative centers for $2.4 billion.  Because Genesis is private, no FFO multiple data was provided.  Health Care REIT states that the transaction will accretive to its earnings.

Big Health Care Merger
I just saw on Bloomberg.com that senior care and medical property owner Ventas, Inc. is purchasing Nationwide Health Properties, Inc. for $5.4 billion.   The combined company will, apparently, be the largest health care REIT in the United States.  I am trying to get more information on the valuation.   Both companies have medical office properties and hospitals, but it appears that the biggest component is senior housing and skilled nursing.

Update:  I was told by an industry insider that he was hearing that the deal was priced at 17 to 18 times NHP's FFO, which must be this year's anticipated FFO.  NHP had FFO of $2.14 per share in in 2010, based on its results released yesterday.  The trailing multiple was 21 times 2010's FFO, which dropped to 19.5 times using NHP's $2.30 of AFFO.

More Environmental News
Here is an article from yesterday's New York Times to cheer you up on a Monday.  The article goes in depth on waste water generated in natural gas drilling. 

Sure it’s got to go up. But how much?
Here is an interesting item on health care costs from a website called The Incidental Economist.  Below is a graph from the post above:

The disconnect on health care spending in the US is startling.

Please Explain This To Me
The hotel market is confusing.  In San Diego, the 670-room Hotel Del Coronado just sold for $880,000 per room.  Across the San Diego Bay, another luxury hotel, the 1,625-room Manchester Hyatt, just announced that it is under contract for $351,000 per room.  I understand that more rooms may result in a lower price per room, but for two luxury hotels in the same town, the price dichotomy seems large.  I don't know for sure, but I doubt a night's stay at the Hotel Del costs more than twice much as a night at the Manchester Hyatt.

Inland Western and Borders
I did a quick cross reference between the Borders stores in the Inland Western portfolio and the list of planned Borders closures.  I count only five of the eleven Borders in the Inland Western portfolio that are closing.  Stores closing stinks, but with the size of the Inland Western portfolio - 312 properties and nearly $6 billion of investment in properties - the closure of five stores seems small.  The Inland Western website is excellent for searching out properties and tenants.

I will post on Inland Western's planned stock listing in the next few days.

Strong Correlation
I am not an economist, but I read plenty of economic articles.  It doesn't take an economist to connect the strong relationship between housing and the unemployment rate. When the housing market was booming unemployment dipped below 5%.  When the housing market tanked unemployment rose.  Now the housing market and the employment market are both stagnant.  I believe that unemployment will stay high until the housing market rebounds, which means a significant increase in new home sales and housing starts.  (Note that the housing figures released yesterday showed a 14% increase in housing starts in January over December, but all the growth was in multifamily units, and single family starts actually declined 1%, and are at their lowest level in two years.)  I recently read two articles that tie my theory together.

Here is an article on the "new normal" unemployment rate, which one economist estimates is 6.7%.  I don't doubt this number, as all the jobs related to housing bubble, such as in construction, real estate sales, design, and finance (how many people do you know who are former mortgage brokers or real estate agents?) will not rebound to the levels seen during the boom.  I think that the housing boom was responsible for dropping the unemployment rates down from 6% to under 5%. 

Here is a second article from yesterday's Wall Street Journal (no subscription required) on how banks now require more equity for homeowners.  Here are a few paragraphs and a graph from the article:

The median down payment in nine major U.S. cities rose to 22% last year on properties purchased through conventional mortgages, according to an analysis for The Wall Street Journal by real-estate portal Zillow.com. That percentage doubled in three years and represents the highest median down payment since the data were first tracked in 1997.

 

The move to force home buyers to lay out more cash is driven mostly by banks, who have found that larger down payments discourage delinquencies by increasing the buyers' exposure to loss and reducing the impact of declining prices. Many home buyers placed little, if anything, down during the boom.

Keeping otherwise qualified and willing borrowers on the sidelines makes no sense to me.  I am not advocating going back to the crazy mortgages of the mid-2000s, but the swing of the pendulum, 22% down payment and strict credit guidelines, has gone too far.  Easing credit in a sensible manner will help the housing market.  It will help eliminate excess supply, and hopefully start a sustained increase in home values.  Existing homeowners (and banks!) will benefit from increased values.

Real estate has always been finance driven, the more money available, the more people will buy homes.  The demand for homes is there, banks just have to meet it.  Homeowners need equity in a home, or they will treat the home like a rental, which is what happened during the housing bubble. Having a financial stake in home is vital, but current draconian terms are going to prolong the housing mess.  Lending policies that make home ownership easier should drop unemployment.  Without a prudent easing of home lending credit terms the housing market will stay in its current bog and unemployment won't drop to its "new natural" level.