Maddening Distribution Information

Does anyone else hate when non-traded REITs only present daily distribution data?  I just received an 8-K from Hines REIT with this frustrating disclosure:

These distributions will be calculated based on shareholders of record each day during the month of August 2011 in an amount equal to $0.00138082 per share, per day and will be paid in October 2011 in cash or reinvested in stock for those participating in Hines REIT's dividend reinvestment plan. Of the amount described above, $0.00041425 of the per share, per day dividend will be designated by the Company as a special distribution which will be a return of a portion of the shareholders’ invested capital  and, as such, will reduce their remaining investment in the Company. 

Please, if you want to state distributions in fractions of cents, add a summary that tells investors the annualized distribution rate and whether the rate has been dropped, increased or maintained from the previous period.  If the distribution rate changed, state the previous rate.  When I see a daily distribution rate with no perspective, I immediately think the REIT is obscuring bad news.   I'm too busy to check, did Hines REIT increase, decrease or maintain its distribution, at what distribution rate, and how much was the special distribution?

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. 

Must Read

I recommend that you read this thread on REITWrecks, which discusses a small offering from American Realty Capital.  The author mixes detailed research, withering commentary, and bruising snark to produce one of the best financial blog posts I have read in some time.  This post needs to win some kind of "excellence in blogging" award.

Bloomberg Baffler

I had to read this headline a few times:

Tiger Woods New Caddie Pick Favors Fanny Sunesson, Irish Betting Site Says

Jump in Commercial Real Estate Prices

Here is a Bloomberg article detailing a 6.3% jump in commercial real estate prices in May over April's prices.  I saw this article this morning but didn't read it until this evening when the large price jump figure hit me.  Here are the first three paragraphs of the article:

U.S. commercial property prices increased in May for the first time in six months as a rebound in distressed real estate helped boost values, according to Moody’s Investors Service.

The Moody’s/REAL Commercial Property Price Index rose 6.3 percent from April, the largest gain since the measure began in 2000. It’s down 11 percent from a year earlier and 46 percent below the peak of October 2007, the company said today.

The index, which measures broad price trends, had fallen to a record low in April as sales of distressed properties undermined real estate values. Distressed deals in May began contributing to rather than delaying a price recovery, according to the Moody’s report.

I know there is plenty of noise in a monthly price figure, but a 6.3% increase is still impressive.

The article also provides price data from Greenstreet and CoStar, both that showed year-over-year price increases.

Misstatement

What a difference a few weeks makes.  The New York Times made a big misstatement in its non-traded REIT slam article from yesterday.  The article stated that American Realty Capital Trust (ARCT) recently valued its shares at $6.62 per share.  Here is the quote:

But nontraded trusts are now required to update their net asset values every 18 months after their initial offering, and their own disclosures to the S.E.C. show their values dropping well below the price at which the shares were originally issued. For example, one REIT, American Realty Capital Trust, recently reported that its shares, which had been sold at $10, were now worth $6.62. The sponsor, American Realty Capital of New York, raised $2.3 billion in the last 18 months, according to its chief executive, Nicholas S. Schorsch. Other sponsors, including Cole, have reported similar declines in share price, public records show.

ARCT closed its primary offering last week at $10 per share, and is not required to make a new valuation for eighteen months.  ARCT did not recently revalue itself at $6.62, and made an 8-K filing this morning stating so and has asked the NYT to correct its error.   ARCT raised its full offering of $1.5 billion, with over $300 million coming in June alone.  I wonder what, if any, impact the article would have had if it was printed in early June?   Did the NYT confuse ARCT with another REIT?

Update:  The New York Times corrected the above article and added this language to the end of the article:

This article has been revised to reflect the following correction:

Correction: July 20, 2011

An earlier version of this article misstated the share price for American Realty Capital Trust.  It was sold at $10 a share, but the current value is not known. It is not $6.62, which is the REIT’s net tangible book value.

Insurance Company Lenders

Here is a Bloomberg article from late last week describing how portfolio lending insurance companies are now competing for big commercial loans with Wall Street banks that make loans and then package and sell them as mortgage backed securities.  The article details how Pacific Life and Met Life are expected to beat out big banks for a loan on a 55-story office tower in San Francisco's financial district.  Last week Wells REIT II announced a $325 million loan from Pacific Life for the Market Square office complex in downtown Washington DC that the REIT acquired earlier this year.  In a side note, Wells REIT II has now retired all the short-term acquisition financing (bridge loan and line of credit) it used to acquire the property.

Too Late Baby

The Bancroft family has second thoughts about selling the Wall Street Journal to News Corp. 

No Pressure - Industrial Income's Line of Credit Requirement

Most non-traded REITs obtain a line of credit to help facilitate acquisitions and other activities.  The lines of credit come with plenty of restrictions and covenants, and are complex financial instruments.  These restrictions and covenants vary per line of credit, and may include limits on a REIT's leverage, require certain minimum debt coverage ratios, and place conditions on a REIT's distributions.  Yesterday, I read (in a filing) a new requirement as part of Dividend Capital's Industrial Income Trust's new $40 million line of credit.  The lenders are requiring Industrial Income, starting for the period ending September 30, 2011, to raise equity of $60 million a quarter (or $20 million a month).  Here is the language from Industrial Income's July 1, 2011, Post Effective Amendment No 5:

The Revolving Credit Agreement requires that as of the end of each month, commencing with September 30, 2011, we must have generated gross proceeds from the Equity Offering equal to an aggregate amount of at least $60.0 million during the previous three full calendar months, which we refer to herein as the “Minimum Equity Raise Requirement.” If we fail to meet the Minimum Equity Raise Requirement, 100% of the net proceeds of our Equity Offering must be applied to reduce amounts outstanding under the Revolving Credit Agreement until we are able to meet the Minimum Equity Raise Requirement. In addition, if we fail to generate at least $30.0 million in gross proceeds during the previous three full calendar months, the Borrower may not draw any amounts under the Revolving Credit Agreement until such condition has been satisfied.

Industrial Income raised over $100 million in the first quarter of 2011, so the requirement does not seem to pose a current concern.  I don't have a problem with this restriction, and mention it because I have not seen this requirement before.  I think it is a smart move by the bankers.  Industrial Income is lucky that the lenders did not require the REIT to do something audacious, like pay even a portion of its distribution from operating cash flows (read page S-2 of the July 1, 2011, Post Effective Amendment No 5).

Good News For Apartments

Here is a Calculated Risk article on Reis's apartment report.  Vacancies are down and rent is up.  Vacancies stood 6% nationally at the end of the second quarter and rents at $997 per month.  For the year earlier period, vacancies were at 7.8%, and rents were at $974.  This is a marked improvement.  Here is Calculated Risk's opinion on the impact improving rental market:

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 8,700 apartments came on the market in Q1 (in the Reis survey area). This is the second lowest quarter since Reis has been tracking completions - the lowest was 6,000 last quarter.

• The falling vacancy rate is pushing push up effective rents. This also pulls down the price-to-rent ratio for house prices.

• 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 or 2013, so vacancy rates will probably decline all year.

My bold and italics added in the last bullet point.  I hope Calculated Risk's right that an improving apartment market can help GDP and the employment rate.

Dumb Article of the Day

This article that predicts the worst ten housing markets for the next five years has been on Yahoo Finance's top news stories all morning.  What a dumb article.  How the heck do its two authors (or anyone else) have any clue what the worst housing markets will be for the next five years.  I want the three minutes back it took me to read the article and write this post.

CMBS Pro Formas Return

Here a Financial Times Alphaville blog post on the re-emergence of loan underwriting based on pro forma financial data rather than historical figures.  In the 2000s most loans in CMBS were based on pro forma underwriting.  Here is a strong quote from the post:

In market terms, pro-forma underwriting is the practice of basing future property cashflows on estimates rather than historical income streams. In non-jargon, it often means picking numbers out of thin air and basing your valuations on them. Even the rating agencies are pretty down on the method. Moody’s says that “almost always pro-forma underwriting is a negative for credit quality."

Anyway, recent concerns seem to stem from this report from Barclays Capital:

Although CMBS 2.0 deals so far are nowhere close to 2007 vintage in terms of pro-forma underwriting, we start seeing isolated examples where some loans were underwritten using forward looking assumptions … Historically, clean underwriting was traditionally based on the most recent 12-month trailing financials. However, we see that a significant number of loans in CMBS 2.0 were underwritten 1) either significantly higher than 12-month trailing; or 2) historical numbers were not quoted in Annex A, making such comparison impossible. In many instances the lack of historical operating performance was in those cases where relatively new construction (assets built or substantially remodeled within the prior three years and even not fully stabilized) was securitized. In addition, for the recently acquired properties, historical financials might be not available or are just considered less reliable, as the sponsorship changed. Based on our analysis, the combination of these two factors explains most of the instances where the historical financials were missing … On average, about 18% of all CMBS 2.0 loans did not have historical NOIs [net operating income] …

Hard to tell whether this is a trend or a few anomalies, but it did not take long for old habits to reappear.  

Cole REIT Announces Exit Strategy

In a short 8-K filing yesterday, Cole Credit Property Trust II announced that is exploring liquidity options, which it expects to complete within the next twelve months.  Here is the language:

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.

This simple statement clearly presents the REIT's intention to list on an exchange or sell the portfolio within a year.  Of course, the liquidation process may take more than a year, but telling reps and investors a specific date is a target Cole will have to stand by and defend. 

Naural Gas Overestimates

Here is another Sunday link, this time to a New York Times article on the natural gas industry.  The article details how industry projections for shale drilling in three separate formations are not matching expectations, and that shall drilling may end up being more expensive than forecast.  Here is a passage summarizing the article:

Company data for more than 10,000 wells in three major shale gas formations raise further questions about the industry’s prospects. There is undoubtedly a vast amount of gas in the formations. The question remains how affordably it can be extracted.

The data show that while there are some very active wells, they are often surrounded by vast zones of less-productive wells that in some cases cost more to drill and operate than the gas they produce is worth. Also, the amount of gas produced by many of the successful wells is falling much faster than initially predicted by energy companies, making it more difficult for them to turn a profit over the long run.

Here is a longer, second passage buried deep in the article:

Production data, provided by companies to state regulators and reviewed by The Times, show that many wells are not performing as the industry expected. In three major shale formations — the Barnett in Texas, the Haynesville in East Texas and Louisiana and the Fayetteville, across Arkansas — less than 20 percent of the area heralded by companies as productive is emerging as likely to be profitable under current market conditions, according to the data and industry analysts. 

Richard K. Stoneburner, president and chief operating officer of Petrohawk Energy, said that looking at entire shale formations was misleading because some companies drilled only in the best areas or had lower costs. “Outside those areas, you can drill a lot of wells that will never live up to expectations,” he added.


Although energy companies routinely project that shale gas wells will produce gas at a reasonable rate for anywhere from 20 to 65 years, these companies have been making such predictions based on limited data and a certain amount of guesswork, since shale drilling is a relatively new practice.
Most gas companies claim that production will drop sharply after the first few years but then level off, allowing most wells to produce gas for decades. 

Gas production data reviewed by The Times suggest that many wells in shale gas fields do not level off the way many companies predict but instead decline steadily. 

“This kind of data is making it harder and harder to deny that the shale gas revolution is being oversold,” said Art Berman, a Houston-based geologist who worked for two decades at Amoco and has been one of the most vocal skeptics of shale gas economics. 

The Barnett shale, which has the longest production history, provides the most reliable case study for predicting future shale gas potential. The data suggest that if the wells’ production continues to decline in the current manner, many will become financially unviable within 10 to 15 years. 

A review of more than 9,000 wells, using data from 2003 to 2009, shows that — based on widely used industry assumptions about the market price of gas and the cost of drilling and operating a well — less than 10 percent of the wells had recouped their estimated costs by the time they were seven years old.

Terry Engelder, a professor of geosciences at Pennsylvania State University, said the debate over long-term well performance was far from resolved. The Haynesville shale has not lived up to early expectations, he said, but industry projections have become more accurate and some wells in the Marcellus shale, which stretches from Virginia to New York, are outperforming expectations.

This article presents nothing new for people that follow the oil and gas industry.  Rosy forecasts that fall short, and costs that exceed expectations have been a hallmark of the oil and gas industry for as long as I have been looking at it, so it makes sense that newly drilled shale formations would cost more and produce less than anticipated.

Sunday Morning Links

I've had two tabs open in my browser for several days in anticipation of writing a longer post on the housing market, jobs and the economy.  I am not going to get to that post anytime soon, but wanted to link the tabs anyway.  The first is from The Economist's Free Exchange blog and is about housing leading the way to a sustained economic recovery.   The second link is to a Wall Street Journal article, (via Yahoo Finance), also discussing housing but from the finance angle.  Is describes mortgage bond security guru Lewis Ranieri's latest venture, which is starting a private, non-traditional lender to step into the mortgage market because banks' credit standards are too restrictive.  Yes, the "subprime" word is mentioned, but I'm convinced Ranieri's and others' ideas on the mortgage market make sense.  I have come to the conclusion that housing is the key to jobs and economic growth, and until housing improves the economy will struggle. 

Rip Van Veres

I saw this Bob Veres' Financial Planning article yesterday morning.  I've read it a couple of times and wonder where Mr. Veres has been the past ten years.  (I will state upfront that this post is not a bash on Bob Veres just this one article, as I have read his material for nearly twenty years, and he has forgotten more about the financial planning industry than I'll ever know.)  Sorry to break this to you Bob, but non-traded REITs are not a "new category of investments."  The non-traded REIT business is now nearly a $100 billion industry, based on data I have seen recently published, and grew through steady equity raise of $5 billion to $10 per year over the past decade.  The comparison of the current non-traded REIT business to the limited partnership boom of the 1980s is weak. 

I broke into the broker / dealer industry in the late 1980s as a junior analyst assigned to the "continuing" due diligence department at a mid-sized independent firm.  Continuing due diligence was a fancy term for the saps assigned to field angry calls from brokers, and sometimes their clients, to tell them that their limited partnership investments were worthless.  A trial by fire.  Coming out of college, I had no clue what a partnership was, and in a short period my bosses that knew answers to questions were fired, so I had to educate myself.  Big partnership sponsors like August, Balcor, Equitec, VMS, Krupp and a slew of smaller ones all went away.  One of the biggest syndicators was Dallas-based Hall Financial Group, run by Craig Hall, which specialized in apartments.  He too failed.  (His afterlife has not been all bad.  His wife was an ambassador to Austria under President Clinton, Craig Hall's current firm is still doing real estate, and he and his wife run a respected wine business, although I won't buy a bottle.)  

The limited partnership business of the 1980s that Bob Veres is trying to compare to today's non-traded REIT business, was marked by massive failure.  Veres states that these deals collapsed under the weight of their fees, costs, expenses and deal structures.  This is true to a point.  Does anyone remember the infamous land deals that where structured as two offerings, one debt and one equity, where the debt investment was used to buy the raw land and the equtiy was used to pay interest on the debt and carry the land for a supposedly short period?   These deals did not end pretty.  I think a case can be made that a favorable tax code, which lead to the overbuilding of commercial real estate, and also caused the S&L collapse, hurt limited partnerships as much as fees.

Most limited partnerships lost their properties or were consolidated into other entities.   The term "Roll-Up" is still a four-letter word in the independent broker / dealer world because of the disastrous late 1980s and early 1990s roll-ups of Equitec, VMS and Krupp, which became the innocuous named entities Hallwood, Banyan and Berkshire, respectively.  Two roll-ups that kept their names, Realty Income Corp and Public Storage, worked out pretty well for investors that stuck around.

The non-traded REIT business of the late 1990s, lead by Wells and Inland, and since with multiple sponsors, has been marked by the lack of catastrophic failure.  This is amazing considering the 49% drop in commercial real estate prices from their 2007 peak.  Some REITs are struggling, as evidenced by net asset valuations of REITs like KBS REIT I, Inland Western, Dividend Capital's Total Realty Trust, Behringer Harvard's Opportunity I and others, which are all valued much less than the original $10 per share offer price.  But while these REITs have seen their net asset values drop, there is no talk (that I know of) of these REITs ceasing to exist.  As noted above, commercial real estate in the 1980s was driven by a favorable tax code that lead to signfianct over building.  Commercial real estate in the 2000s did not, for the large part, have the overbuilding that marked the 1980s, which has helped the non-traded REITs keep their properties occupied.  The non-traded REITs, in general, do not have the high levels of debt that was common in the 1980s.  These factors, in my opinion, have helped the non-traded REITs avoid the problems that faced limited partnerships in the 1980s.

I think Mr. Veres' article would have been stronger and more relevant, if he'd compared the limited partnership industry of the 1980s to the TIC boom of the 2000s.  This is the better analogy because both were marked by tax driven investors looking to avoid or defer taxes as first consideration, and both had highly leveraged properties.  And like the limited partnerships of two decades ago, it's my opinion that most TIC deals will end up being lost to foreclosure, or more likely consolidated with other TICs.  I don't believe TIC consolidation is a four-letter word, but that's a subject for another post.

The end of Veres' article falls further when he discussses non-traded REIT earnings.  He lists some non-traded REIT earnings, all that are bad.  He needs to focus on Funds From Operations (and NOT Modified Funds from Operations).  FFO for REITs, whether listed or non-traded, is the most widely recognized metric for financial health, due to the large amount of non-cash write-offs afforded REITs.

Another area that separates the 1980s' partnership boom and today's non-traded REIT business in the independent broker/dealer business, itself.  I don't have specifics, but I would guess many independent broker / dealers had partnership business that was probably 50% or more of their total revenue and needed partnership sales for their survival.  Today, broker / dealer executives break into a cold sweat if alternative investments (under which non-traded REITs fall) are more than 10% of revenue. 

One area where Mr. Veres focus was correct was raising the specter of Robert Stanger & Co. in the limited partnership boom of the 1980s and today's non-traded REIT industry.   I'd like to know more about this, too.   It is good that Bob Veres has turned his eye to this "new category of investments," and non-traded REIT sponsors better be ready if a bearded man with a ponytail stands up at a conference and starts asking pointed, uncomfortable questions.  He doesn't take BS for an answer.

Inland Western REIT's New Value

Inland Western filed an 8-K yesterday with a new net asset value per share.  Inland Western estimates that its net asset value was $6.95 per share at March 31, 2011.  This is an increase from early 2010's $6.85 per share valuation.  Here is the opaque language, which now is common place with non-traded REIT sponsors, in the 8-K describing how Inland Western determined its valuation:

The estimated value was determined by the use of a combination of different indicators and an internal assessment of value utilizing internal financial information under a common means of valuation under the direct capitalization method.  No independent appraisals were obtained. Specifically, the estimate of the estimated per-share value was made with primary consideration of the valuation of the Company’s real estate assets which was determined by the Company’s management using methodologies consistent with publicly traded real estate investment trusts in establishing net asset values, and the estimated values of other assets and liabilities determined by the Company’s management as of March 31, 2011.

I was pretty outraged in early 2010 when Inland Western presented a value of $6.85, thinking it too high.  I guess I have mellowed over the past year because I read the filing without much of a reaction.  I think this is because Inland Western, if I am not mistaken, is planning on listing its shares in the near future.  A listing will give a true market valuation of Inland Western, and while its net asset valuation may have some merit, the stock price will be the tangible value.

Areas of Interest

I recently signed up for a nifty data collection service that notifies me any time select public companies make an SEC filing.  I set up the system up to receive notification on about a dozen non-traded REITs, and plan to include most all non-traded REITs in the near future.  Yesterday, Monday, I received a huge data dump from about half the non-traded REITs on my watch list.  The filings were all correspondence between the SEC and the non-traded REITs, with the SEC asking questions and wanting clarifications on these non-traded REIT's filings, in particular 10-Ks. 

All notifications included the initial SEC inquiry, the non-traded REITs' follow-up, any future questions and follow-ups, and the final letter from the SEC saying it had no further questions.   There was a general theme and consistency across the SEC's question and answer with the non-traded REITs.  First, the SEC wanted to know how the non-traded REITs determined their average lease rates and if this average included discounts and rent concessions.  The answer across all REITs was "no," the average lease rates excluded concessions.

Second, the SEC wanted to know how the REITs determined cap rates that the REITs included in their  filings.  To me, this seemed more disclosure related than questioning the actual cap rates, as the SEC didn't seem to have an issue with "average" cap rate (which I discussed here), it just seemed to want to know the formula used for calculating the disclosed cap rates.  The cap rates are all pro forma based on the non-traded REIT's estimate for first year net operating income (which is then divided by the purchase price to determine cap rate), or in the case of the averagers, the average pro forma NOI over the anticipated hold period divided by the purchase price. 

Finally, the SEC had questions on Modified Funds from Operations.  I get the sense that the SEC holds MFFO in about as much esteem as I do.  To paraphrase my take on what the SEC was inquiring about regarding MFFO, and again this was a theme across multiple non-traded REITS, was it was trying to determine why the non-traded REITs exclude acquisition costs from MFFO because REITs are in the business of buying and selling real estate, which obviously involves costs.  The response was that non-traded REITs exclude acquisition costs to make prior period comparisons more meaningful.  I am not going to argue this point, but will continue to discount MFFO until a REIT has fully invested its equity and MFFO really only consists of adjustments for straight line leases. 

Fifteen Cents on the Dollar - Vegas Style

Late last month I noted a land sale in Arizona that sold for eight cents on the dollar based on peak mid-2000s pricing.  Here is another example, this time in Las Vegas.  Calculated Risk and the Las Vegas Sun detail a property in Las Vegas (not sixty miles away like the discounted Arizona land sale) that sold for $30.2 million in 2007 and just sold for $4.4 million, an 85% discount.  For some reason, seeing Southwest land sales at discounts of 92% and 85% made me wonder how IMH Mortgage Holdings' portfolio is maintaining its value.

Vintage Years

When I think of vintage years and investing, I think of venture capital or private equity deals.  It is my opinion that the concept of vintage years evolved as a way for managers (and marketers) to explain away poor performance.  They created an excuse to blame bad deals and weak returns on the year in which a fund made its investments, rather than lousy investment decisions.  I have never really heard it widely applied outside the VC world, but its a concept that needs wider application.   Some real estate sponsors can make a strong case to play the vintage blame game. (And can't equipment leasing sponsors blame every year on the vintage?)

I have always been aware of vintage issues related to real estate investments, or, really, any pooled investment that raises and invests money over a particular time period.  This idea solidified when I was recently reviewing the performance of two, large non-traded REITs, both with identical objectives, acquisition philosophies and management, that were issued by the same large real estate sponsor, and that raised about the same amount of investor equity.  The only difference was when the REITs raised and invested capital.  From a performance perspective, the two REITs are Jekyll and Hyde, night and day, black and white.  The REIT that raised and invested money in 2006 to 2008 is having troubles and the REIT that raised and invested money in 2009 to 2010 is looking solid. The first REIT is not alone, as many REITs that were raising money over the same time 2004 to 2008 frame are facing a difficult environment.

I always thought of REITs, even non-traded REITs, as open-ended corporations with infinite lives that had the ability to actively buy and sell property, and that would eventually have a a mix of real estate, bought over different periods.  I did not pay too much attention to the years when the REITs were buying property, as I thought it would all even out over time.  Now I don't believe this.  When a REIT buys its initial portfolio will make a big difference in its long-term performance.  While you can't predict with certainty how current markets will relate to the future or what the future will bring, it is clearly an issue that needs consideration.