Worst To First

Las Vegas, the city hit hardest by the housing crisis, saw the biggest rebound in new home starts in the fourth quarter, as the housing rebound continues to grow, according this Bloomberg article.  Las Vegas' new home construction surged 96% in the fourth quarter over the year earlier period.  It was followed by other hard hit areas like Naples-Ft Meyers, FL, and Atlanta, GA.  The Vegas numbers sound pretty incredible until you read this passage:

The 1,426 single-family houses started in the Las Vegas area in the fourth quarter is down from the peak of 7,873 in the third quarter of 2004, according to Metrostudy.

New home starts in Las Vegas, despite nearly doubling in the fourth quarter, were less than a fifth of their peak.  It's important to note, too, that the peak was in the third quarter of 2004, not in 2007 or 2008.  Vegas, like Phoenix and California, saw its housing bubble burst far earlier than other parts of the country, making its rebound seem more credible, and the low number of starts compared to the peak years makes me believe the housing rebound is sustainable over time.

Why There Are No Distressed Deals

There are no distressed deals because the big boys get first chance at all the choice deals.  Here is a Bloomberg article on Barry Sternlicht's Starwood Property Trust buying LNR, a commercial mortgage backed security special servicer that is the largest manager of distressed commercial mortgage loans.  The following passage from the article lays out why the distressed deals are few and far between:

The deal gives the Greenwich, Connecticut-based companies a window into some of the more than $1 trillion of commercial real estate debt scheduled to mature in the next five years in the U.S. and Europe, as well as access to pricing of troubled properties and income from fees. LNR’s special servicer business, which represents bondholders in debt restructurings and foreclosures, is the biggest manager of distressed U.S. commercial real estate loans.

“It is a major-league transformative deal,” said Joshua Barber, an analyst with Stifel Nicolaus & Co. in Baltimore. The transaction will give Starwood Property “real size, real scale, unbelievable networks and real mortgage originators.”

Starwood Property gained 4.6 percent to $25.11, the highest closing price since the stock began trading in 2009. The real estate investment trust and competitors including Colony Financial Inc. (CLNY) and Apollo Commercial Real Estate Finance Inc. (ARI) went public that year to try to capitalize on distressed property after the credit crisis.

With Starwood, Colony, Apollo and similar well capitalized firms getting first crack at the best deals there not many quality deals left for smaller investors, and the following is evidence why the top investment firms' will continue to get the best deals:

The company (Starwood) will benefit from having access to LNR’s $131 billion of loans where it is the named special servicer, said Andrew Sossen, chief operating officer and general counsel.

“The information is priceless,” he said in an interview. “As a special servicer, you have a view into what rents are in any given city on any given street in the U.S, to the extent you have a property there. With $131 billion worth of loans, that gives you a data point and a look into the commercial real estate markets throughout the U.S.”

Dumping Distress And Going To School

Here is another one of those Bloomberg articles that start with one topic, but then goes on to include a bunch of other important information.  Toll Brothers, the US's largest luxury home builder, is shutting down its distressed investment vehicle and getting into building high-end college dormitories.   This passage jumped out at me:

As Toll enters the dormitory market, it’s “winding down” its distressed real estate investing division, Gibraltar Capital and Asset Management LLC, Yearley said.

“The deals aren’t there,” Yearley said.

Toll Brothers started Gibraltar in 2010 to buy portfolios of foreclosed properties and nonperforming loans from banks following a collapse in demand for new housing. Toll’s peak investment of $135 million in Gibraltar has declined to $125 million, Yearley said.

I have been hearing from real estate fund sponsors about distressed opportunities for years, and I've just never seen a sizable amount of attractive, large dollar deals.  Small, nimble investors have been able make money in small, broken deals, but but I have not seen the anticipated wave of high quality properties in upside down financial positions. 

And here is the case for student housing:

College enrollment is expected to increase by at least 10 percent by 2016, as “echo boomers” enter their late teens, fueling demand for student housing on and off campus, according to Axiometrics Inc., a Dallas-based research firm specializing in apartments.

Demand for student housing was less robust than expected during the first half of the 2012-2013 school year, according to an October report by Andrew McCulloch of Green Street Advisors Inc., a Newport Beach, California-based firm that researches real estate investment trusts.

“A challenging economy, new supply and overly aggressive rent hikes were the main culprits,” McCulloch said. “Newer, more amenitized assets in close proximity to campus have been, and are expected to continue to be, outperformers.”

Cole's Big Deal

I feel like Lloyd Bridges character in Airport!, I picked the wrong day to be out of the office.  Yesterday while I was at a meeting and traveling, away from a non-mobile phone internet connection, Cole Credit Property Trust II (CCPT II) announced that it is merging with NYSE-listed, Scottsdale-based Spirit Realty Capital, Inc. (SRC).  The merger valued CCPT II at a price of $9.36 per share, or an exchange value of approximately 1.9 CCPT II shares for each Spirit share.  According to the CCPT's filing documentation, there are no internalization fees or transaction fees payable to Cole as a result of the merger.

Spirit's stock shot up after the announcement, and by the end of trading yesterday the market was valuing CCPT II at $10.00 per share, or the price investors originally paid.  Spirit's stock is continuing to rise today.

Summaries of the transaction are below:

Wall Street Journal

InvestmentNews

Bloomberg

CCPT II investors will receive Spirit shares when the merger closes, and there is no lock-up or deferred liquidation.  CCPT II investors will have full liquidity when the merger closes, which is expected to occur sometime in the third quarter.  Before the deal closes the best way to check the value of the transaction for CCPT II shareholders is to multiple the price of Spirit's shares by .525.

Plenty could happen between now and when the deal closes later this year.  But today, it's hard to see this transaction as anything but positive news for investors. 

The Influence Of Housing

I have commented numerous times on housing and its impact on the economy.  Here is a short, information filled summary of housing data from Calculated Risk.  Housing starts were up 28% in 2012, but at 780K new starts, it was still the fourth lowest year of housing starts since records began in 1959, with the three other years being 2009 through 2011.  Here is more data:

• Starts averaged 1.5 million per year from 1959 through 2000.  Demographics and household formation suggests starts will return to close to that level over the next few years. That means starts will come close to doubling from the 2012 level.

• Residential investment and housing starts are usually the best leading indicator for economy. Note: Housing is usually a better leading indicator for the US economy than manufacturing, see: Josh Lehner's The Handoff – Manufacuturing to Housing. Nothing is foolproof as a leading indicator, but this suggests the economy will continue to grow over the next couple of years.

In many markets the housing bubble began to lose air seven years ago.  That's a long time with declining and stagnant prices.  The housing sector is now contributing to GDP, and this will continue and help other sectors like retail.  The housing recovery is just getting started and has a long run ahead. 

Crank Up The Way Back Machine

In TNP Strategic Retail's prospectus supplement filed yesterday, it stated that it is actively negotiating with Glenborough LLC to replace the REIT's current advisor.  Glenborough, or a derivative of the current Glenborough, was formed sometime in the late 1980s or early 1990s through the roll-up of multiple August Financial limited partnerships.  There is a bizarre circle of life in the world independent broker / dealer direct investments. 

InvestmentNews' Take On TNP

Here is the InvestmentNews article on TNP Strategic Retail Trust's filing yesterday.  The author, Bruce Kelly, hits on all points in filing.  The article has this passage:

Meanwhile, against nontraded-REIT industry norms, Mr. Thompson last week sent a notice to broker-dealers hawking the TNP Strategic Retail Trust. “Closing Feb. 7, 2013!” the note stated. “Necessity retail: Now is the time!”

The note to broker-dealers stated that the REIT's current net asset value was 6% higher that its share price. “As of Nov. 9, 2012, estimated NAV increased to $10.60. Shares continue to be offered at $10,” the note read. 

The notice referenced above is still being sent to broker / dealers, even after the filing. 

Canary In The Coal Mine

Early yesterday, TNP Strategic Retail Trust Inc. filed a short update with the SEC, and it's a must-read for anyone following the non-traded REIT industry.  In the filing, among other big issues, the REIT disclosed that it may not be in compliance with provisions in two of its secured loans, one a revolving line of credit with KeyBank secured by five properties, and the second a loan on a single property.  In addition, the REIT disclosed that its November 9, 2012 value of $10.60 per share may not be an accurate measure of the REIT's current value.  TNP Strategic Retail's problems, in this blog's opinion, show huge cracks in the operations of non-traded REITs and will have broader implications for the entire industry, particularly in financing and REIT-created valuations.

Lines of credit have become vital to non-traded REITs, and KeyBank provides many non-traded REIT financing facilities.  Bankers may design creative financing options, buy they're ultimately lemmings, and conservative in making broader decisions.  I'd suspect KeyBank is frantically reviewing all its loans to non-traded REITs, because with banker mentality one sour episode means all non-traded REITs are now suspect.  The easy money provided non-traded REITs by banks - which come with a long list of negative covenants - gives non-traded REITs plenty of opportunity to over borrow and get into financial trouble. 

The typical non-traded REIT credit arrangements have conditions that must be maintained, or negative covenants are triggered.  The conditions vary per financing transaction, and so do the negative covenants.  For example, a non-traded REIT may have low cost financing as long as it raises a certain amount of equity per month or keeps total leverage below certain levels, and if the REIT fails to meet these requirements then the interest rate may increase, a large principal payment could be due, or the loan could be considered in default.  This is common sense, but non-traded REITs need to borrow within their means, not based on future fund raising or financing events.

TNP Strategic Retail's disclosure that its November 2012 value of $10.60 per share may not be accurate is an understatement.  (This blog questioned this REIT's valuation methods in August 2012 when the value was a mere $10.40 per share).  Non-traded REITs have upfront costs that typically range from 10% to 12%, excluding acquisition and financing fee and expenses.  If a REIT's offer share price is $10 and its offering costs are $1.10 (11%), it's left with $8.90 (89%) to invest in real estate.  This $8.90 of real estate then becomes the REIT's net assets.  No real estate investor can consistently buy assets at an across the board 13% discount, which is the amount of appreciation needed for a non-traded REIT to recover an 11% load.  There is no acquisition arbitrage, and if there was one, every finance company and investment bank on Wall Street and beyond would inundate non-traded REITs with capital until the arbitrage disappeared. 

Recent mid-offering revaluations, across multiple REITs, have magically resulted in net asset values greater than the initial share offer prices.  This is not shocking because if a non-traded generated a value less than its offer price - even though the offering costs are fully disclosed - the fear is new equity sales would plummet (and remember those negative covenants!).  The whole revaluation process has become nothing more than a mid-offering marketing boost.  The thin credibility behind advisor generated valuations, whether the advisor gets a rubber stamp from a third party firm or not, has been shattered by TNP Strategic Retail.  (I'd be nervous if I was a Strategic Retail independent board member that approved the $10.60 per share value just two months ago when the impending financial problems were looming.) 

After non-traded REIT sponsors get over their Tony Thompson schadenfreude, they better look closely at their own shops and realize TNP Strategic Retail's situation is an industry harbinger.  Bankers are not your friends or partners - they're sheep with self-interest.  Today's easy, short-term money could become difficult money quickly, and non-traded REIT advisors better understand this.  The charade of internal, advisor generated valuations must stop.  Offering costs are real - which is OK - and can't be revalued away.  Unfortunately, the industry can't or won't fix this problem as long as the revaluation marketing efforts are successful, which means responsibility will fall to regulators.

Positve Signs For The Office Sector

Via Calculated Risk, here is the latest from Reis on the office sector.  Vacancy rates declined in the fourth quarter to 17.1% from 17.2%.  This was not the data that caught my eye.  Rents increased nearly 1% during the quarter, the strongest gain since 2008.  In 2012, 12.025 million square feet of new office space was completed, down from 15.164 million square feet in 2011, and we know 2011 was such a banner year.  New construction is expected to continue at its current low pace.  I like that rents are increasing with limited new supply.

Lifestyles Of The Rich And Famous

Northstar's CEO and Chairman, David Hamamoto has sold his Fifth Avenue co-op apartment in Manhattan for $50 million, the price he was asking. 

Big Merger

American Realty Property Trust III, Inc. (ARC III) agreed on Friday, December 14, 2012, to merge with NASDAQ-listed American Realty Capital Properties (ARCP).  The $3 billion ARC III / ARCP combination provides investors' two liquidity options.  Investors can choose to receive cash of $12.00 per share, or shares in the merged company with a value of $12.26 per share (based on ARCP's $12.90 stock price at the time of the announcement multiplied by 95%).  The transaction is expected to close in the second quarter of 2013.

ARCP disclosed a planned post-merger distribution of $.90 per share.  To current ARC III investors, this is the equivalent to a yield of 8.66%, or a jump of over 31% from ARC III's 6.60% yield. (It's an approximate yield of 7% to investors buying ARCP stock today.)

ARCP and ARC III have similar management and are affiliated with AR Capital, the sponsor of multiple non-traded REITs.  In reading the filing information, ARC III and ARCP had separate investment bankers and only the independent directors of each company voted on with merger, with the AR Capital-affiliated directors that sit on both companies' boards - Nicholas Schorsch and Michael Weil - abstaining from the merger vote.  The following is from the investor letter describing the transaction's advisors:

BofA Merrill Lynch is acting as exclusive financial advisor and Duane Morris LLP is acting as special legal counsel to ARCP in connection with the transaction. UBS Investment Bank is acting as exclusive financial advisor and Weil, Gotshal & Manges LLP is acting as special legal counsel to ARCT III in connection with the transaction. Proskauer Rose LLP is acting as corporate counsel to ARCP and ARCT III.

This is not the first affiliated transaction in the non-traded REIT industry.  WP Carey has been merging its offerings for years, with its most recent merger completing this fall.  ARCP is already a listed company and the market doesn't hide its opinion of deals it doesn't like.  ARCP's stock is holding steady after the announcement.

The merger produced a mountain of paperwork which needs analysis.  My initial thoughts are that investors have two options, both of which are attractive as of today.

AR Capital continues to press the industry with the speed to liquidity and return to investors of its ARC Trust REITs.  Liquidity and exit strategies, once nebulous events dismissed as future possibilities, are now critical when talking about non-traded REITs. 

What's The Opposite of Accretive?

De-cretive? Di-lutive?  Di-sappointing?  None a pretty word.  I posted Tuesday about Cole Credit Property Trust II's suspension of its distribution reinvestment plan and its share repurchase plan.  I speculated that the suspension of the two plans could be the initial steps toward CCPT II's liquidation.  Another idea floated through my brain after re-reading CCPT II's lawyerly disclaimer sentence in CCPT II's investor letter (emphasis added):

While no final decisions have been made, CCPT II anticipates being in a position to announce further updates regarding a potential liquidity event in the near future. 

What if all the entities supposedly looking at CCPT II were proposing values below its current distribution reinvestment price of $9.35 per share, and share repurchase price of $9.31 per share? If this is the case, the board's decision to suspend the distribution reinvestment program and share repurchase program makes sense and doesn't necessarily signal an imminent liquidity event.

Buying shares back at prices higher than the shares' value is bad business, the board cannot knowingly overpay for assets.  On the other hand, if the estimates of share value were higher than the share repurchase and reinvestment price, it'd be in CCPT II's shareholders' best interest to buy as many shares as possible at the undervalued price.  CCPT II's redemption requests have exceeded actual redemptions:

During the nine months ended September 30, 2012, we received valid redemption requests pursuant to the share redemption program, as amended, relating to approximately 15.2 million shares, including those requests unfulfilled and resubmitted from a previous period, and requests relating to approximately 4.6 million shares were redeemed for $43.2 million at an average price of $9.31 per share. The remaining redemption requests relating to approximately 10.6 million shares went unfulfilled, including those requests unfulfilled and resubmitted from a previous period. Requests for redemptions that are not fulfilled in a period may be resubmitted by stockholders in a subsequent period.

I reviewed redemption requests for both Dividend Capital's Diversified Property Fund (DPF) and CNL Lifestyle, both of which raised equity capital in the mid-2000s.  Like CCPT II, both redeem far fewer shares than requested.   But both REITs increased redemptions after recent revaluations revealed a lower net asset value per share than the previous redemption price.  DPF redeemed 1% of its shares in the second quarter, but redeemed 25% of requests in the third quarter after it lowered the value of its shares.   Lifestyle, after its August revaluation, increased the amount of shares it was willing to redeem per quarter.  The implication to me is that both DPF's and Lifestyle's boards were hesitant to repurchase too many over shares at prices greater than what the boards believed the respective REIT's actual net asset value.  There are many reasons for a non-traded REIT to limit redemptions and buying shares back at prices higher than a REIT's asset value is but one. 

I guess we'll know shortly whether CCPT II's board's decision to suspend CCPT II's distribution reinvestment and share repurchase plans were a precursor to a sale or an act of fiscal prudence.

Initial Steps

Cole Credit Property Trust II filed an 8-K this morning announcing that the REIT has suspended its distribution reinvestment program and its share repurchase program.  The 8-K included a letter to investors stating that "while no final decisions have been made, CCPT II anticipates being in a position to announce further updates regarding a potential liquidity event in the near future." 

Suspension of share repurchase and distribution reinvestment plans are generally some of the first steps by a non-traded REIT preparing for liquidity. 

Lodging Regains Pre-Recession Levels

I meant to post this Calculated Risk link yesterday.   Hotel occupancy rates are now at their best levels since late 2007, or before the credit crisis and recession. RevPAR (revenue per available room), one of the key hotel operating metrics, increased 6.2% over the past year.  The chart below from Calculated Risk presents occupancy information for various periods. 

Houston, We Don't Have A Problem

Here is a comprehensive article from the New York Times (via yahoo.finance) on the national apartment market.  It's full of information and worth reading.  The authors are amazed that even Houston is seeing strong demand for multifamily units.  The article ends on this high note:

Andy McCulloch, the head of residential research at Green Street Advisors, a real estate analysis firm, said it was a misconception that growing momentum in the single-family housing market would hurt the rental market.

“If the single-family market gets better it could help jobs, it could help incomes and you could see rent continue to rise,” he said. Constraints on lending, Mr. McCulloch said, will also keep a lid on the number of new homeowners.

“If I was an apartment landlord, the only thing that would really freak me out from the buying side is the return of easy credit,” he said. “But that doesn’t seem to be coming back anytime soon.”

Fresh & Awful

Here is a Bloomberg article on British retailer Tesco's plans to leave the US market through the sale or closure of its Fresh & Easy grocery stores.  There is a Fresh & Easy store near my house and it's a horrible shopping experience.  It has limited inventory (part of Fresh & Easy's concept) and its non-house brand inventory is expensive.  I never shop at Fresh & Easy for more than a handful of items, usually food and grocery basics, but it never fails that Fresh & Easy is out of stock or does not carry one or more of things I went in to buy.  I don't like to see stores fail, but the Fresh & Easy concept has been a missed opportunity from the start.

Legacy Non-Traded REIT Breaks Even

Last week, an affiliate of Blackstone Group agreed to buy David Lerner & Associates' Apple REIT Six for $11.10 per share, through a combination of cash and preferred shares in the Blackstone entity.  According to InvestmentNews, Apple REIT Six raised its capital from 2004 to 2006 at a price of $11.00 per share.  Not knowing anything about this deal, but considering it was offered before the credit crisis and invested in hotels, one of the hardest hit asset classes, giving investors a breakeven price seems like a good deal to me.

OMG - It's A Frenzy!

Housing mania has returned.  The grip to buy is immediate and tightening.  Here is a Bloomberg article from last week about the frenzy in Las Vegas, where the housing supply is about 1.5 months, which is low.   Foreclosures have disappeared and people are rushing back to the market.  My own anecdotal example is of an acquaintance who bought an approximate 800 square foot condo for over $600K - sight unseeen - so not to miss the opportunity.  Peoples' memories are short.  Everyone needs to take a deep breath, step back, and tell themselves they aren't going to miss any opportunities in the home price rebound.  It's been seven years since the housing market peaked and it's not going to regain all its lost ground in a few weeks. 

If A Fee Falls In A Forest

AR Capital has made a subtle change to the compensation structure of its non-traded REITs.  Rather than take an asset management fee in cash, it has opted to take the asset management fee in units of the operating partnerships through which the non-traded REITs own and operate their real estate.  AR Capital has subordinated receipt of this fee to investors receiving a return of capital, plus a specified annual return, generally 6%, resulting from a liquidity event.  So, before AR Capital gets its asset management fee, it must return an investor's original investment, plus 6% per year.  Payment of the asset management fee is therefore not assured.  This is separate from any other incentive compensation AR Capital may earn from its REITs.

Asset management fees provide sponsors with steady, recurring revenue, which is not based on any performance or return to investor hurdles.  The asset management fee, because of its predictability, is a disincentive for sponsors to provide liquidity to investors, especially if liquidation incentive fees appear unobtainable. Over time, the asset management can become the only compensation a sponsor is ever going to receive.  When a non-traded REIT lists to go public, one of the first changes is elimination of the asset management fee, which tells you all you need to know about the validity of this fee.

I have not read of or heard of any other sponsor following AR Capital's lead.  Frankly, I'll be surprised if other non-traded REIT sponsors emulate the ARC fee change, even though they should.  Until investors, brokers and broker / dealers cry about this fee, or start making investment decisions contingent on this fee, sponsors will let AR Capital defer its fees while they keep collecting the asset management fee.   Because the asset management fee is generally stated in small percentage amounts - 1% or .75% of asset value, for example - its insidious impact - particularly over the long-term - is overlooked. It locks investors into a REIT because sponsors have no incentive to provide liquidity and stop receipt of the asset management fee.

While the above is all good and well, if AR Capital's focus is to get its REITs' equity raised and invested, and then provide REIT investors liquidity through a sale or listing, why not eliminate the asset management fee altogether?    If AR Capital eliminates asset management fees, its competitors will feel the pressure from broker / dealers to cut or eliminate asset management fees.  Investors will be the real beneficiaries of lower fees.

That's Alotta Money

Here is a slide from a Northstar Realty Finance Corp (NRF) presentation to a securities conference last summer:




NRF sponsors the Northstar Real Estate Income Trust, a non-traded mortgage REIT.  Interesting to see how much money a sponsor expects to make from its non-traded REIT.  NRF, according to the footnotes, expects to earn 3% per year on equity capital from asset management, origination, acquisition and disposition fees.  I don't see any expectations for potential incentive fees.  Wait, there is no incentive when the sponsor is earning 3% per year!

The slide above is public information and was extracted from an 8-K that NRF filed with the SEC on September 5, 2012.   You can search NRF's filings to see the entire presentation.