The Double-Dip Express

Cole Credit Property Trust III's (CCPT III) letter to investors last Wednesday, and this Seeking Alpha article call CCPT III's acquisition of its sponsor "transformational."   A better word is "retro." The merger is resurrecting a dead fee.  CCPT III is reversing full speed to the early 2000s when non-traded REITs routinely paid big internalization fees to acquire their external advisors.  I thought those days were gone, and even proclaimed the final passing of internalization fees last summer when Wells REIT II announced it would not buy its external advisor.  Sponsor's don't forget big paydays, however, especially when they don't require shareholder vote as in the case of CCPT III buying its sponsor, Cole Holdings.   Cole's move shows the internalization fee is alive and flourishing; a Phoenix that just won't stay dead.

Buried deep in a filing CCPT III made last Friday, is the share price over which Cole starts to earn its subordinated incentive listing fee.   This share price is $10.45.   After 180 days, if the newly listed stock's average price for the subsequent thirty days exceeds $10.45 per share, Cole receives 15% of this profit in stock.  (Cole has agreed to reduce its subordinated incentive listing fee by 25% due to the internalization fee.)  Cole only receives this fee after investors have received a full return of their capital plus an 8% annual return.

I am not going to try and predict the future price of the CCPT III/Cole Holding stock when listed, but is $10.45 that far out of reach?  The market's reaction to the two recent American Realty Capital Trust transactions (three if you include Realty Income Corporation's purchase of ARC Trust), the WP Carey and CPA 15 transaction, and even the Cole Credit Property Trust II / Spirit Realty transaction, makes it apparent that the market likes the steady income of long-term net leased real estate.  If you include CCPT III's dividend increase and the expected accretive benefit of the transaction, $10.45 seems closer than ever.

Subordinated incentive listing fees - not internalization fees - were designed as a sponsor's big payday.  After a non-traded REIT returned investor capital plus a preferred return, a sponsor shared in profits.  Subordinated incentive listing fees are not assured, which, I am guessing, is why Cole is leaving nothing to chance and is taking a large internalization fee, which is nearly $150 million at a $10 per share stock price, and obviously more if the stock price exceeds $10.00 per share.

Based on in formation in last Friday's filing, I have created the following table showing the internalization fee, including the fee at a 25% discount, at various stock prices for the new Cole Real Estate Investment:

Cole Credit Property Trust III Potential Subordinated Incentive Listing Fee*
Shares Outstanding	481,367,453
Share Price	$10.00	$10.45	$10.75	$11.00	$11.50
Value	$4,813,674,530	$5,030,289,884	$5,174,700,120	$5,295,041,983	$5,535,725,710
Profit	$(216,615,354)	$-	$144,410,236	$264,752,099	$505,435,826
15%Profit Sharing	$-	$-	$21,661,535	$39,712,815	$75,815,374
25% Discount			$16,246,152	$29,784,611	$56,861,530

I determined Cole's potential Profit at several share price levels.  I first determined several possible market capitalizations by multiplying the number of Shares Outstanding by potential stock prices.  To determine Profit, I then took the difference between the various market capitalizations and the market capitalization at $10.45 per share.   No Profit is earned until the share price exceeds $10.45 per share.  Above $10.45, Cole's subordinated incentive fee is 15% any Profit.  Before Cole receives this fee, investors will have received a full return of their original investment, plus an 8% annual return. 

The table also shows Profit Sharing less 25%, which is the amount that Cole is reducing any subordinated incentive listing fee due to it taking an internalization fee.  This is the amount added to Cole's internalization fee.

I am not aware of another instance where a sponsor received both an internalization fee and a subordinated incentive listing fee.  I am sure that it's partly the case that prior non-traded REIT listings or liquidity events where the sponsor received an internalization fee never had subsequent share prices high enough to pay the subordinated listing fee.  The inability to earn a subordinated listing fee is one, if not the main reason why non-traded REIT sponsors began taking the internalization fee in the first place.

If the CCPT III's purchase of Cole Holdings is accretive - and I am all for accretive deals that add full liquidity - why doesn't Cole just take its compensation in the form of the full 15% subordinated incentive listing fee.  The more money investors make, the more money Cole makes.  If investors receive a big payday, no one would care, and no one would complain if Cole takes home $75 million ($11.49 per share), or $150 million ($12.53 per share), or $300 million ($14.60), or more.  It's the dang internalization fee that is so troubling. 

I am sure other non-traded REIT sponsors are watching this transaction closely.  If Cole can pull off the duel fees - internalization and subordinated incentive listing fee - and not damage its brand (ability to raise equity through broker / dealers) going forward, I suspect other sponsors will leap back on the internalization train.  Investors better put on a seat belt and grip their wallet tight because its "All Aboard the Double-Dip Express!"

* I determined the figures in the table above based solely on my reading of CCPT III's filed documents, without any verification of any share adjustments or valuation formulas and are for illustrative purposes only.

ARCP and COLE Merger - Holy Cow!

I wasn't expecting this morning's merger news that American Realty Capital Properties (ARCP) agreed to buy Cole Real Estate Investments (COLE).  After last spring's rancorous battle when ARCP tried to buy non-traded REIT Cole Credit Property Trust III (CCPT III) before it merged into its sponsor and became COLE, I thought the ill will would have left ARCP and COLE adversaries for some time.  It just proves I shouldn't think.

ARCP is buying COLE for $6.85 billion.  ARCP will pay a fixed ratio of 1.0929 ARCP shares for each share of COLE, valuing the transaction at $14.59 per share based on yesterday's close.  ARCP is offering to acquire up to 20% of COLE shares for cash at a price of $13.82 per share.  The boards of each company have approved the transaction and shareholders in both companies must now approve the merger.  The transaction is expected to close in the first half of 2014. 

ARCP expects to raised its dividend to $1.00 per share, up from the current $.94 per share, upon closing the merger.  This is an increase for both COLE and ARCP investors.  The combined company will be the largest net lease real estate company in the United States with over 3,700 properties and a $21.5 billion enterprise value, according to the joint press release announcing the merger.

There is an old James Bond movie called Never Say Never that clearly applies here.  Money helps, too - it's the ultimate business salve for bruised egos and hard feelings.  Today's offer is a premium to ARCP's final offer last spring of $13.59 per share in stock or $12.50 in cash for CCPT III, although that offer didn't include COLE's syndication business, which has exceeded pre-listing expectations. 

This deal is a nice move for COLE shareholders and COLE executives.  The merger represents a 14% premium over yesterday's close for COLE.  As I noted last spring, the breakeven point for COLE to earn its incentive listing fee was $10.45 per share.  At $14.59 per share COLE set for another big pay day.  Based on the table I presented last spring, COLE is set to receive a $224 million incentive listing fee at the $14.59 price, and Chris Cole who owns 10,624,788 shares (much received as part of the non-internalization internalization), sees his stake now worth $155 million, and upon completion of the merger all shares will likely vest, no longer subject to the multi-year lock-up.

There is plenty to consider on this transaction, but on the surface I'm still trying to mentally absorb the big news.

Payback, Baby!

When Cole Credit Property Trust II (CCPT II) announced its merger with Spirit Realty earlier this year and there were no internalization fees to CCPT II's advisor or sponsor, a little voice inside my head kept saying this is too good to be true.  That little voice is crowing so loud this morning I am starting to get a headache.  Cole's altruism in CCPT II has morphed into avarice in Cole Credit Property Trust III.

Cole Credit Property Trust III (CCPT III) announced in an 8-K filing this morning that it is purchasing an affiliate, Cole Holdings Corporation.  The merged entity is changing its name to Cole Real Estate Investments, Inc., and plans to list on the NYSE in the second quarter.  This is a liquidity event for investors in CCPT III.  The new entity, Cole Real Estate Investments, Inc., is increasing its distribution to a 7% yield for a CCPT III investor.

CCPT III is paying a handsome price for its affiliate.  It is paying $20 million in cash and 10,771,225 in shares of Cole Real Estate Investments.  If you value the shares at the $10 per share price paid by investors for their shares of CCPT III, this equals $107,712,250.  The REIT pays Cole another 2,142,245 shares once the new entity lists on the NYSE, and again assuming the $10 per share price, this is another $21,422,450 million.  The grand total is $149,134,700.   The shares paid have a lock-up period, with one-third released on closing and then the remaining two-thirds released in two annual increments. 

There is an undisclosed "earn-out" amount determined in 2017, and payable at the end of 2017, based on the Cole Real Estate Investments hitting performance objectives not listed in today's filing. 

Wait, there is more.  The REIT's advisor still can receive a subordinated listing fee:

Upon listing of the Company’s common stock on a national securities exchange, a fee equal to 15% of the amount by which the market value of the Company’s outstanding stock plus all distributions paid by the Company prior to listing, exceeds the sum of the total amount of capital raised from investors and the amount of cash flow necessary to generate an 8% cumulative, non-compounded annual return to investors will be paid to CR III Advisors (the “Subordinated Incentive Listing Fee”). 

The subordinated listing fee is not paid until investors get a specific level of return - their investment in CCPT III plus 8% per year.  This fee, if earned, is paid six months after the listing.  Cole is reducing it by 25%.

CCPT III is externally advised by an affiliate, and I didn't read in the filing that the REIT internalized its advisor, so I am assuming that the REIT will continue to pay an asset management fee .50% on its average invested assets.   CCPT III had more than $7 billion in assets at September 30, 2012.

This is a great deal for Cole.  It circumvented the whole stigma of the internalization process but still takes home $150 million (assuming a $10 stock price), with the possibility of much more.  Not only that, it still keeps its asset management fee of .50%.  I think this is called having your cake and eating it too, with ice cream, whip cream, a cherry and chocolate sauce on top. 

I don't want to come off completely negative.  It's positive that CCPT III investors are getting liquidity, and it's positive that investors that elect to keep their shares are getting a distribution increase of $.50 per share, or nearly an 8% increase.  CCPT III closed its offering period just about a year ago, so the time to liquidity was much faster than anticipated.  From what I read it's a fully liquidity event for investors, not a multi-tranche staged liquidity.  The market and investors will ultimately judge the merits of this transaction.

UPDATE:  In the original post I forgot to included that Cole is reducing its subordinated asset management fee by 25%.  I have added it above.

I didn't read in the filing today that CCPT III internalized its management.  One of the bullet points in the filed presentation states that the REIT will no longer pay external management fees.  This could read property management fees, asset management fees, or both.  I took it as property management fees because the property manager is part of Cole Holdings, which is being acquired by CCPI III.  Another bullet point states that Cole Real Estate Investments will earn property management fees from other non-traded REITs sponsored by Cole, in particular Cole Credit Property Trust IV and Cole Corporate Income Trust.

Good News / Bad News?

I try to stay away from politics on this blog, but one thing I noticed after Tuesday's election was how wrong some of the professional pundits were in their pre-election predictions.  If so many pundits can make shot-in-the-dark guesses why can't I?  I can't help but wonder whether Cole Credit Property Trust III's successful sale of the Microsoft Property is good news before some unpleasant news on Cole Credit Property Trust II's (CCPT II) pending liquidation.  CCPT II announced in the summer of 2011 that it would seek a liquidity event within twelve months.  This date came and went with no announcement. 

In late August 2012, CCPT II filed an 8-K announcing that it had hired two investment bankers.  This was good news, and a step forward towards liquidation, but there is still no news on an exit strategy nearly three months later.  I won't believe Cole is serious about liquidity until it waives any internalization fees.  Wells REIT II waived internalization fees earlier this year, and KBS REIT II waived internalization fees this fall.  These were significant developments for the non-traded REIT industry, and a continued referendum on the stigma of internalization fees.  The longer Cole is quiet on this huge potential payday, the less convinced I am that Cole is serious about CCPT II liquidity or foregoing an egregious internalization fee.

There is another factor that I'm sure plays against the liquidity and internalization fee waiver:  the increasing deficit between CCPT II's 8.0% preferred return and its 6.25% current distribution.  This figure grows daily, diminishing Cole's chances of sharing in liquidation profits.  I am going to get wonky, but follow the premise.  CCPT II is paying a 6.25% distribution, and its annual preferred return, or hurdle rate, is 8.0% per year.  When the REIT provides investors a return of capital and an 8.0% per year return, its advisor shares in 10% of all additional proceeds. (The 10.0% incentive amount is less than many other non-traded REITs.)  Any annual shortfall essentially gets added to the initial share price, increasing the price needed before Cole is paid its incentive fee.  The current annual difference for CCPT II is $.175 per share per year ($.80 perferred return, less $.625 current distribution).  CCPT II has never paid a distribution equal to its preferred return, so the annual deficit has been added to the initial share price since the initial distribution in late 2005. 

The longer Cole waits the bigger the hurdle becomes.  I figure the approximate accumulated difference at $1.0625 per share, through September 2012.  This requires any liquidation event price to exceed $11.0625 before Cole begins to share in its 10% incentive fee.  (I'm sure CCPT II's investment bankers have spent considerable time figuring the exact share price where CCPT II's advisor starts to receive its incentive.)  I am not going to predict a liquidation value for CCPT II, I'll let the market determine that, but I will state that the longer CCPT II waits to liquidate the more the deficit grows.  Time is not Cole's friend. 

(CCPT II pays its advisor an asset management fee of .25% of its aggregate asset value, which is low compared to many other REITs, and not in my opinion, a strong financial incentive to delay a liquidation.)

This brings us back to the internalization fee.  This is a big potential payday, which can run into the tens to hundreds of millions of dollars, especially for a REIT the size of CCPT II.  If Cole thinks an incentive fee is out of reach, an internalization fee looks all the more enticing.  Wells REIT II has a similar dynamic, maybe more so than CCPT II - a long-term deficit between its distribution and its preferred return - and it waived its internalization fee.  It was the right decision, and it met industry expectations. 

Political pundits are in a safe bubble and none have any repercussions - the networks will keep calling no matter how wrong their predictions.  I hope Cole isn't in a delusional bubble where it believes it can slip a large internalization fee past investors.  That would be bad for Cole and bad for the industry.  Cole needs to build on the success of its Microsoft Property transaction, not ruin it with bad news on CCPT II's liquidation.  Unlike the political pundits, I hope I'm wrong.

Getting Ready to Wait

Cole Credit Property Trust II (CCPT II), in response to its now year-and-a-half-old liquidity event proclamation, disclosed in an 8-K earlier this month that "numerous potential bidders" are looking at all or part of the REIT.  The 8-K also said that Cole has asked the bidders to submit any offers by the end of November, which is fast approaching.  I, for one, am not delaying Holiday shopping plans waiting around to analyze an early-, mid-, late- or post-December 8-K filing detailing a liquidity event for CCPT II.  I'll believe it when I see it.

Is it me or is the "or part" language interesting?  Except as I discuss below, I'm skeptical that Cole would sell CCPT II in three parts - single tenant retail, multi-tenant retail and office and industrial.  CCPT II's prior disclosures have mentioned partial sales before, but this is the first time three distinct portfolio sectors have been identified.   A partial sale would be messy and time consuming.   The second best scenario for Cole is an all-cash sale where it can try get as much money as possible recycled into its two current non-traded REITs.  In my opinion, the best option for investors is one where they receive full, immediate liquidity  - none of this staged, multi-period listing nonsense - while keeping the option to continue receiving a high distribution.

I have stated before that I think Cole will try and pull a WP Carey and provide liquidity to investors while keeping control of CCPT II's assets. Slicing the portfolio into thirds makes this hypothesis / guess less a stretch.  Cole's Corporate Income Trust can buy the office assets while Cole Credit Property Trust IV buys the retail assets.  This is the best scenario for Cole.  Heads Cole wins, tails Cole wins. 

A commenter in my last post on CCPT II stated correctly that in a complete asset sale Cole would not have to internalize its advisor.  While true, I don't see Cole, or any non-traded REIT sponsor that hasn't waived an internalization fee, selling a portfolio without negotiating some form of liquidation payday, whether through internalization or some other form.   Cole didn't hire two investment bankers for nothing. 

$12.50 and $13.59

The ink wasn't even dry on the press release announcing that Cole Credit Property Trust III (CCPT III) had rejected American Realty Capital Properties' (ARCP) latest $13.59 per share buyout offer when CCPT III proclaimed that it had completed the purchase of its sponsor, Cole Holdings.  Here is a Bloomberg article on the purchase.  The speed of the completion tells me the outcome was fait accompli - CCPT III was intent on buying its sponsor regardless of any outside offer, whether from ARCP or any other company.  CCPT III's Special Committee really was special - for Cole Holdings.

This morning, Chris Cole, 100% owner of Cole Holdings, is $20 million in cash richer.  He also pocketed 10,711,225 shares of CCPT III stock, and gets another 2,142,245 shares of CCPT III stock when CCPT III lists it shares.  At $10.00 per share, the price paid for their shares by CCPT III investors, this totals nearly $150 million.  (And don't forget all the additional compensation - including a $7.5 million upfront cash bonus as part Mr. Cole's new employment package,  a potential Subordinated Incentive Listing Fee (at a benevolent 25% discount) if the new Cole Real Estate Investments, Inc. trades above $10.45, and a future, potential "earn out" in 2017, all of which could push the price CCPT III paid for Cole Holdings much higher then $150 million.)  

If I have learned one thing over the years it's that the only thing a rich guy wants is more money.   When a rich guys feels entitled to a big payday and sees big wad of investor cash that can make a payday happen, the avarice is compounded.   

While Chris Cole's $20 million Friday is easy to determine and tangible, the outcome for investors this morning is less certain.  ARCP's last offer for CCPT III was either $12.50 per share in cash, or shares in ARCP with a value of $13.59 per share for CCPT III investors.   CCPT III's Special Committee rejected this offer as insufficient, among other reasons.  Cole, to date, has offered no price assurance to investors upon the listing of Cole Real Estate Investments.  It now has its lofty price points - $12.50 per share and $13.59 per share - and they are known by every investor, broker, broker / dealer and Cole competitor. 

Silence In The Desert

A year has come and gone since Cole Credit Property Trust II (CCPT II) announced on June 28, 2011:

On June 28, 2011, Cole Real Estate Investments announced that it is actively exploring options to successfully exit CCPT II’s portfolio within the next 12 months, and that the potential exit strategies it is looking at include, but are not limited to, a sale of the portfolio or a listing of the portfolio on a public stock exchange. 

In May, I noted that it appeared Cole was hedging its one-year liquidation time frame, so the casual passage of the specified twelve months was expected.  CCPT II has not provided an update to its planned liquidation date.  My personal opinion is that CCPT II is not going to liquidate any time soon, and that when it does, it won't take an internalize-and-list format.  I think Cole will try and somehow follow the WP Carey model where it will offer investors liquidity, possibly through the merger with another affiliated entity, while keeping control of CCPT II's assets, estimating that most investors will choose to stay invested in the REIT rather than liquidate.  CCPT II is a $3.4 billion REIT, so separating it from Cole and listing it as its own company would leave a big hole in Cole's asset base.

There is another factor to bear in mind, and one that probably has as much to do with Cole's decision as does the potential loss of assets.  CCPT II has an 8% annual preferred return hurdle it needs to achieve before its advisor can receive its 10% liquidation carried interest.  CCPT II has never paid an 8% distribution, so any annual short fall is added to the REIT's stock price.  For a simple example, with CCPT II's $10.00 initial offer price, it needs to generate $.80 per year (8.0%) in preferred return distributions.   If it only generates a $.65 per share (6.5%) in distribution in one year, the difference, of $.15 per share is added to the $10.00 share price (again this is only an example to illustrate the carried interest mechanics and is not based on actual CCPT II results). 

So, in the above example, $10.15 per share is the new price at which CCPT II would have to achieve upon liquidation before its advisor starts to earn its 10% carried interest.  So, given this example, if CCPT II were to liquidate for $10.25 per share, its advisor is entitled to 10% on the $.10 per share difference between the liquidation price of $10.25 per share and the $10.15 per share hurdle price.  If CCPT II liquidates below its hurdle price, its advisor does not earn its liquidation carried interest.

Each year, any shortfall to the 8% preferred return is added to the initial share price to create a new hurdle share price.   Because CCPT II has not generated the 8% annual preferred return, its hurdle share price now exceeds $10.00 per share.   I don't know the exact share price at which CCPT II would have to list at or sell for before its advisor begins to receive its carried interest, but it would be an important number to know.   I'm sorry to trudge off into the wild explaining the arcane features of liquidation carried interest, but it's important because most sponsors are going to make decisions that will pay them the most money.

While the 8% preferred return is favorable for investors, CCPT II's advisor has no incentive to liquidate unless it believes it has a reasonable chance of earning its 10% carried interest.  It's a Catch-22, the longer CCPT II delays liquidating, the higher its share price becomes before its advisor can earn its carried interest (unless somehow the REIT starts paying an 8% distribution).  If CCPT II were to internalize its advisor, it would lose the property management and asset management fees it now earns.  CCPT II's ever increasing hurdle rate share price, which makes achieving the carried interest more difficult, along with losing the asset management and property management fees, to me, increases the likelihood Cole will attempt to try and maintain CCPT II's assets even as it figures a way to provide liquidity to investors.

I am not against Cole trying to imitate the WP Carey model, in fact I'm all for it if Cole can pull off a positive return to investors while providing real liquidity to investors.  Investors in WP Carey funds have fared well with this model.  I like that investors can either liquidate or choose to stay invested and maintain their distribution and real estate allocation.   There are plenty of conflicts of interest with the WP Carey method- valuation and sponsor compensation, come to mind - but this is a topic for another post.  

I have no knowledge of Cole's plans for CCPT II, and speculate only as an internal parlor game.  I'll be watching its filings looking for direction.  Cole is on record stating that is seeking "options to successfully exit CCPT II's portfolio," so it will have to give an update either way on its liquidity plans in the near future.

Open Market

Cole Real Estate Investments' (COLE) stock is trading on the NYSE.   Early this morning Cole announced a $250 million Dutch Auction tender offer, where it will purchase properly tendered shares at prices "not greater than $13.00 nor less than $12.25 per share."  The tender offer expires August 8, 2013.  The $250 million tender offer represents approximately 5% of the equity raised in Cole Credit Property Trust III.  Following the completion of the tender offer, COLE has made available additional $250 million to repurchase shares on the open market.

In a June 5, 2013, filing, COLE stated that it expected to have $500 million available to fund a tender offer and a secondary market purchase program to support liquidity in the period following listing.  So, the $500 million is being split between the tender offer and the share repurchase program.

This morning COLE announced that Christopher Cole agreed to waive a $7.5 million equity award.

COLE, in initial trading, is pricing above the $10 per share paid by investors, but less than the tender offer prices. 

The Acquisition

Non-traded real estate investment trusts buy and sell (mostly buy) properites every day, and no one transaction seems more memorable than any other.  But then in the summer of 2010 Cole Credit Property Trust III (CCPT III) purchased a $310 million office building, and it instantly became an acquisition everyone was talking about.  The building, located in a suburb of Seattle, was over 95% leased to Microsoft, and I know it as the Microsoft Property.  Cole has been justifying the acquisition of the Microsoft Property ever since.

Other non-traded REIT sponsors whispered that they too had reviewed the property, but had passed on it because it was too expensive, giving a strong implication that Cole overpaid.  Cole was accused of style drift - what else could it be if a retail-oriented REIT spent so much money on a single office property?  You must be ever-vigilant for the horror of style drift in the strict, stratified world of non-traded REITs. 

CCPT III has sold the most infamous property in recent non-traded REIT history, giving Cole some justification and vindication.  The Microsoft Property, which was purchased for $310 million, was sold for $375 million.  Cole's spite at the industry seeped into its press release (emphasis added):

“When our experienced real estate team brought this opportunity to us in the summer of 2010, despite industry naysayers, we felt this acquisition would be an excellent fit for our growing portfolio of mission-critical corporate properties,” said Marc Nemer, Cole’s president and chief executive officer. “Today, not only have we seen a 21% increase in the property's value, but we were able to deliver a return of 38% on the equity invested, creating significant value in the portfolio for the benefit of our shareholders.”

Now that the Microsoft Property has been sold, the industry can focus its full attention on the ever-pending liquidity options for Cole Credit Property Trust II.

On a serious note, CCPT III paid a pre-payment penalty of $12.8 million as part of the Microsoft Property sale. The property had a $156 million mortgage that was repaid at closing. I figure the pre-payment penalty was 8.2% of the outstanding balance on the mortgage. Is is me or does this seem like a high percentage?

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.

In The (No) Money

This blog has been harsh on Cole Credit Property Trust III's decision to acquire its sponsor.  But I need to point out what's happening with Cole Credit Property Trust II (CCPT II) and its merger with Spirit Realty (SRC).  Back when it was a game to speculate about CCPT II's liquidity plans, I determined that for Cole to achieve its subordinated listing fee, its stock would have to trade above $11.06 per share.  This was as of September 2012, and was probably high based on the timing of all investors into CCPT II, but then a few more distribution periods have passed that would have increased the price.  So, I am guessing an "in the money" price of $11.06 is not too far off the mark, over which Cole gets a 15% subordinated incentive listing fee.   Today, SRC's stock closed at $21.53 per share, giving a CCPT II conversion price of $11.30 per share ($21.53 times the conversion ratio of .525).

There is only one problem.  Cole waived any subordinated incentive listing listing fee when it agreed to the merger with Spirit.  With an agreed upon January merger price of $9.36 per share for CCPT II stock, waiving a incentive that that required a nearly $2 per share appreciation (nearly $4 for SRC) over six months was probably not a tough decision.  Conversely, I imagine that Cole probably could have kept the subordinated incentive listing fee for the same reason.  I could also argue that since SRC's management is going to take over the combined SRC / CCPT II portfolio, it needs deserves credit for the stock increase, too.  It'd be tough, however, to argue that SRC's stock has not benefited from potential addition of the CCPT II assets.

I'll caution that the CCPT II / SRC merger is yet complete and not scheduled to finalize until early in the third quarter.  Things can change in a short period, but today it looks like Cole waived a fee it would have earned.

COLE Listing

According to InvestmentNews, Cole Real Estate Investments is listing its shares on the New York Stock Exchange tomorrow under the symbol COLE.  COLE raised $4.9 billion in equity through Cole Credit Property Trust III.  InvestmentNews had no information on the pricing for COLE's $500 million tender offer, and I have no additional information on the listing other than what's in the article. 

COLE-List-mas Eve

I feel like an eight-year old on Christmas Eve!  Cole Real Estate Investments' (COLE) imminent listing is the most exciting event to hit the world of non-traded REITs, since, well, ARC's last liquidity event.  Tomorrow, COLE's $4.9 billion of investor equity - which was raised over multiple years - becomes fully liquid, and we still don't even know the price COLE will offer to tender $500 million of shares.   How exciting!  At least I won't have to wait for the adults to get back from church to open presents.  I expect Santa to deliver a wave of emails filled with COLE filing data by 4:00 a.m. 

It stinks getting old.

Another Profile In Courage

I just re-read the InvestmentNews article I linked to earlier today.  It seems lame to me that the broker / dealer that terminated its Cole relationship last week waited so long.  This blog and other publications listed all the fees related to the Cole Holdings / Cole Credit Property Trust III transaction back in March.  Pulling selling agreements then would have sent a stronger, more effective message than waiting four months. 

I guess the supposed (passive-aggressive) punishment is to deny Cole reinvestment dollars when reps sell shares of Cole's two recent liquidity events.  But to me, this begs a bigger issue: BDs are scared of liquidity events because their reps are selling shares of the newly liquid, but established, fully invested REITs and reinvesting back into high commission blind pool REITs.  BDs don't want to tell their reps "no" and deny them a big payday.  I'd bet this thinking was not only behind the Cole termination, but also played a part in the other BDs' decision to suspend sales of American Realty Capital Trust V, despite the excuses given in InvestmentNews.

Cole's Mountain Of Money... And It's Anthill

Cole Credit Property Trust III (CCPT III) raised a staggering $600 million of equity in February and March as it closed its equity offering period.  Based on an April 20th filing, Cole's subsequent offering to CCPT III, Cole Credit Property Trust IV (CCPT IV), has already raised more than $4.1 million, satisfied its escrow conditions of $2.5 million, declared a 6.25% distribution and acquired five properties.  (It looks like two of the properties were purchased from affiliated entities, but before the alarm bells sound, I'd note that Cole routinely warehouses properties for its funds.)

Cole Corporate Income Trust is another story.  It has been open since February 2011, and has only raised $20 million.  I don't get the divergent sales figures between it and the CCPT funds.  Corporate Income Trust is not that different from CCPT III and CCPT IV to account for such an anemic equity raise.  Oh well, I have much more important things to keep me worried than trying to figure out why the rich isn't getting richer.

Quote of the Year
This is a quote from a July Cole Real Estate Investments' press release describing its $310 million acquisition of a building leased to Microsoft:

Cole expects the average capitalization rate for this property over Microsoft’s remaining initial lease term to be approximately 7.70%.  

Average capitalization rate over the term of the lease?  That's a new one.  A cap rate is a property's first year net operating income divided by the purchase price.  Period.  The use of "average" tells me that Cole is afraid to tell us that the actual cap rate is low, probably lower than the Cole REIT's dividend (and the Cole REIT did cut its dividend by a small amount late in the year).  Don't insult us with made up terms.  Instead, tell us that while the Microsoft property was expensive, it will likely outperform all the other real estate in the portfolio.  Forward any other worthy quotes.

Chips Off The Table

American Realty Capital Properties (ARCP) withdrew its offer for Cole Credit Property Trust III (CCPT III) this morning.  I can't say that I am surprised by the announcement in light of CCPT III completing the acquisition of its sponsor, Cole Holdings, late last week.  In thinking about this transaction-that-wasn't, I'm of the opinion that both companies achieved a short-term victory.  CCPT III was able to fend off the mean "bully" Nicholas Schorsch and ARCP, while Mr. Schorsch was able to adroitly position himself as a CCPT III shareholder advocate.  More importantly, he has shrewdly set benchmark prices for a major competitor; prices that investors, independent broker / dealers and competitors will look to when the combined CCPT III / Cole Holdings lists as Cole Real Estate Investments (CREI) later in the quarter.  How CREI's stock trades relative to the ARCP-set hurdles of $12.50 per share and $13.59 per share - forget the $10.00 per share investors paid for their shares - is the new determinant of success, and the line - either over or under - which Cole or ARCP can claim victory.  While one phase of this saga is over, the epilogue is unfinished.

Cole Merger Article

Here is a good article from InvestmentNews on Cole Credit Property Trust III's decision to dismiss the American Realty Capital Properties (ARCP) buyout offer and maintain its intention to proceed with the internalization of its sponsor, Cole Holdings.  The article was written before CCPT III's 8-K filing yesterday morning, which provided more detail on why it rejected ARCP's offer.  After reading this article and yesterday's filing, I am still of the opinion that Cole needs to provide more information to investors before they can make an informed decision on the merger.  Wait, I almost forgot, the Cole's proposed merger doesn't require a share holder vote.   That's a shame.

Cole Filings

Cole Credit Property Trust III is now Cole Real Estate Investments Inc. (CREI).  As it moves to its listing, CREI made two important filings this morning.  The first stated that CREI has changed its name to the aforementioned Cole Real Estate Investments Inc., and declared a 7.0% distribution, an increase from the previous 6.5% distribution.  CREI appointed Jeffery Holland as President and Chief Operating Officer and Stephan Keller as Chief Financial Officer and Treasurer.  CREI has amended its credit agreements to increase the amount it has available to borrow to $518 million.

In a second filing, CREI provided some listing details.  It will list on the NYSE under the symbol COLE in June.  It is a full listing, so 100% of shares are "freely tradeable on day 1."  CREI expects a $500 million tender offer to support its liquidity, which corresponds to the $518 million of new borrowing capability under the amended credit facility.  The filing did not list a tender offer price, stating instead "details to come."    

Cole Credit Property II's Per Share Value of $9.35

Cole Credit Property II filed an 8-K yesterday announcing its per share value.  Non-traded REITs are required to provide a per share value eighteen months after the close of their offering.  Cole Credit Property II's value is $9.35 per share.  Below is the method used in determining the non-traded REIT's value:

Methodology

     In determining an estimated value of the Company’s shares, the board of directors considered information and analysis, including valuation materials that were provided by CBRE Capital Advisors, Inc. (“CBRE Cap”), an independent investment banking firm that specializes in providing real estate financial services, and information provided by the Company’s advisor, Cole REIT Advisors II, LLC.

     In preparing its valuation materials, CBRE Cap, among other things:

	•		reviewed the Company’s Annual Report filed on Form 10-K for the year ended December 31, 2010, including the audited financial statements contained therein, and the Company’s Quarterly Report filed on Form 10-Q for the quarter ended March 31, 2011, including the unaudited financial statements contained therein;
	•		reviewed other financial and operating information requested from, or provided by, the Company;
	•		reviewed and discussed with senior management of the Company the historical and anticipated future financial performance of the Company, including the review of forecasts prepared by the Company;
	•		compared financial information for the Company with similar information for companies that CBRE Cap deemed to be comparable; and
	•		performed such other analyses and studies, and considered such other factors, as CBRE Cap considered appropriate.

     The board primarily considered four valuation methodologies that are commonly used in the commercial real estate industry and in valuing real estate investment trusts (REITs), all of which were included in the materials provided by CBRE Cap. The following is a summary of the valuation methodologies considered.

Net Asset Value — The net asset value methodology determines the value of the Company by valuing the Company’s underlying real estate assets and its entity level assets and liabilities. The value of the underlying real estate was determined by dividing estimated individual property net operating income by estimated market capitalization rates. CBRE Cap’s materials primarily relied on proprietary research, including CBRE market and sector capitalization rate surveys, as well as comparable transaction data and management guidance, in order to determine market capitalization rates to reasonably estimate the Company’s real estate values. CBRE Cap’s materials also relied on market information obtained from the debt and capital markets, management guidance and public filings of the Company to assist in valuing other entity level assets and liabilities.

		Discounted Cash Flow Analysis — The discounted cash flow analysis utilizes five-year projected cash flows reasonably likely to be generated by the Company and discounts those future cash flows using a rate that is consistent with the inherent level of risk in the business to determine a present value. CBRE Cap reviewed the Company’s advisor’s projection of future cash flows and applied a perpetuity growth rate to the projected year five cash flows to arrive at a terminal value, and then applied a risk adjusted discount rate to the annual cash flows and terminal value to calculate a present value of such cash flows of the Company.
		Public Company Comparables — The public company comparables methodology utilizes a range of Funds From Operations and Adjusted Funds From Operations, trading multiples of similar publicly-traded companies and applies them to the Company’s comparable metric to estimate the value of the Company. CBRE Cap selected comparable companies based on qualitative factors such as sector focus, asset quality and tenant mix, as well as quantitative factors such as company size and leverage, and adjusted the multiples based on the Company’s relative strength or weakness compared to the comparable company for each of the factors, which resulted in a reduction of the comparable company multiples. In addition, CBRE Cap further reduced the multiples to reflect the lack of liquidity of the Company’s shares as the Company’s shares are not traded on a national securities exchange. Comparable public companies utilized in the analysis were public REITs with portfolios that were primarily retail focused and included similar asset types with similar lease structures to the Company’s real estate portfolio.
		Dividend Discount Model — The dividend discount model calculates the value of the Company by discounting estimated future dividend payments by the Company’s estimated cost of capital. CBRE Cap prepared the dividend discount model by utilizing the expected future distribution payments as provided by the Company’s advisor, and reviewed by CBRE Cap, and calculated the Company’s estimated cost of capital using the risk-free, 10-year treasury rate and adding appropriate risk premiums, which included an estimate of the long-term equity risk premium measured as the performance of the S&P 500 over the applicable risk free rate, and further adjusted for any Company specific risk premium.

     The four approaches to valuation noted above each resulted in a range of values for the Company’s per share value. CBRE Cap weighted each result to determine an overall estimated range of value for the Company’s shares. Upon review of CBRE Cap’s analysis and information provided by the Company’s advisor, the board of directors established a per share price of $9.35, which is within the overall range of value provided by CBRE Cap.

The above is plenty of language without saying much about the inputs that really drive valuation.  Minor changes to these inputs - multiples, discount rates, growth rates, etc. - can provide large differences in values.  Until Cole Credit Property II or any other non-traded REIT that lists a per share value is listed or liquidated, I'll view the per share valuations with skepticism.