Industrial Income Trust Re-Price

The non-traded real estate investment trust (REIT), Industrial Income Trust, filed various documents this week, including an updated S-11, in preparation for its follow-on (continued) equity offering, which will begin as soon as its current equity offering period ends its nearly two-and-a-half year offering period in mid-April.  The follow-on offering is for two years, which will make the combined time the REIT raised equity nearly four-and-a-half years.  Industrial Income's board of directors has determined that the REIT will price its follow-on offering at $10.40 per share, up from the current $10.00 per share price of the initial offering.  Industrial Income's follow-on offering is expected to start on April 17, 2012,  giving Industrial Income's sales force approximately six weeks to stress the benefit of buying shares soon to be offered at $10.40 for only $10.00. 

The following is from Industrial Income's Supplement 16 and describes the methodology behind new share price:

Our board of directors arbitrarily determined the offering price in its sole discretion and is ultimately and solely responsible for establishing the fixed offering price for shares of our common stock in the Follow-On Offering. We did, however, engage the services of Duff & Phelps LLC (“Duff & Phelps”), an independent valuation firm, to conduct an appraisal of all of our real estate assets that had been acquired prior to the fourth quarter of 2011. For our assets acquired during the fourth quarter of 2011, Duff & Phelps did not prepare an appraisal but did review each of those properties and concluded that the acquisition prices approximated market value.

Our board of directors also considered certain other factors, including: a discounted cash flow analysis; comparisons against certain publicly-traded industrial REITs with respect to certain operating and financial metrics including occupancy levels, leverage ratios and debt terms, and concentration of properties in top tier markets; the quality and diversity of our properties and tenant base; and the progress in executing our overall investment strategy. However, our board of directors did not consider certain other factors, such as an aggregation premium for the properties in our portfolio or a liquidity discount. Our board determined that the aggregate value of all of our real estate assets, as of December 31, 2011, is approximately $1,162,700,000 (after adjustment for our 51% ownership interest in our existing unconsolidated joint venture). Our board’s valuation for the real estate assets that had been appraised by Duff & Phelps was consistent with the Duff & Phelps’ appraisal. This compares to an original aggregate purchase price (exclusive of transfer taxes, due diligence expenses, and other closing costs) of $1,067,800,000 for these assets. Based on 60.55 million shares outstanding as of December 31, 2011, this appreciation of our real estate assets reflects an implied increase in value of approximately $1.57 per share.

A $1.57 per share increase in real estate asset value, that's nice.  I like how the board included the REIT's "progress in executing our (the REIT's) overall investment strategy" as part of its valuation decision.    According to Industrial Income's third quarter 2011 10-Q, the REIT has never paid any of its distribution in operating cash flow, and the following is from a footnote in the third quarter 2011 10-Q:

For the three months ended March 31, 2010 and June 30, 2010, 100% cash distributions provided by financing activities were funded through offering proceeds. For all other periods presented, 100% cash distributions provided by financing activities were funded through proceeds from our debt financings.

I hope the Industrial Income's board weighed in its valuation decision this REIT's historic inability to pay any of its distribution from operating cash flow.  This is one metric I will follow in 2012.

Washington Slipping

Here is a free Wall Street Journal article on Vornado Realty Trust and its problems due to a weakening commercial real estate market in Washington DC.  I didn't know this market was softening because along with New York and Boston, Washington DC is always listed as one of the strongest real estate markets in the country.  I found these paragraphs interesting:

But Washington's engine of growth has been the federal government. As pressure builds on the government to rein in spending, landlords are getting pinched.

Vornado, a Paramus, N.J.-based real-estate investment trust, declined to comment.

The company's release said 1.1 million square feet was vacated because of a military consolidation program overseen by the Defense Base Closure and Realignment Commission. Vornado projected another 539,000 million square feet will be vacated by the end of 2015. Most of the properties hurt by the program are in Northern Virginia.

Vornado is recommending that seven Northern Virginia properties that secure $600 million of debt go to a special servicer.  Despite the downbeat tone of the article, its states that Washington DC still has the lowest vacancy in the country at 9.4%. 

Grubb & Ellis' Sale and Bankruptcy

Grubb & Ellis sold its assets and entered into a prepackaged bankruptcy yesterday.  Here is a LA Times article on Grubb & Ellis' filing along with historical information on Grubb & Ellis as a company.  Hindsight is always clear, but it's hard to argue that the $725 million price that NNN Realty Advisors paid for Grubb in 2007 didn't signal commercial real estate's market top.  According to the LA Times article, Grubb is selling its assets to Newmark Knight Frank, which itself was bought by New York finance firm BGC Partners in October of last year.  A quote from the article:

"Following a thorough and rigorous process and the evaluation of all available options, we determined that a partnership with BGC provides the best platform for our brokerage professionals, employees and clients," said Thomas P. D'Arcy, chief executive of Grubb & Ellis.

"We believe the transaction will be seamless for our clients, and we expect no disruption to the company's operations. Furthermore, we believe our professionals and clients will benefit greatly by being part of the BGC organization, which, with its recent acquisition of Newmark Knight Frank, will bring together two strong brands to create a powerhouse in the commercial real estate space."

There was no mention of the status of Grubb & Ellis' current financial partners, Colony Capital and C-III, both of which invested in Grubb & Ellis over the past year.  BGC Partners, according to this New York Times Dealbook blog post, shares its CEO with Cantor Fitzgerald.

Oil and Gas Articles

There were two oil and gas articles in last Sunday's Los Angles Times.  The first discusses the strain that the fracking debate is having on a community in Upstate New York.  The second details Texans fighting eminent domain for TransCanada's Keystone XL pipeline.  

ARCT Listing

If you'd been listening it wasn't a bombshell, if you were incredulous it was a shock.  American Realty Capital has been saying for over a year that it was going to list the shares of its $2.1 billion REIT, American Realty Capital Trust (ARCT), as soon as reasonably possible after the REIT closed its equity offering.  It's an understatement to say I was skeptical about a quick listing, call me Captain Incredulous.  Early last week ARCT thumbed its nose at the doubters and filed an S-11 announcing its intention to list on NASDAQ on or near March 1, 2012, under the symbol ARCT.  ARCT closed its equity offering period in July 2011, and the speed with which ARCT has gone from non-traded to a pending listing is the quickest I can remember for a non-traded REIT.  Typically, before a non-traded REIT discusses liquidity options, it will have a minimum hold period of five to seven years from the date it closes its offering, and this this is a loose estimation, as a REIT's board can extend hold periods.  ARCT's quick path to liquidity will pressure other non-traded REIT sponsors to offer the same fast turnaround.

As part of ARCT's listing, it is internalizing its advisor and waiving fees, including any internalization fees.  An internalization fee has historically been a non-traded REIT sponsor's big payday, and is where the listing REIT, with the benevolence of investor capital, buys its external advisor, using REIT stock as currency.  The price the REIT pays for its advisor is the internalization fee, and historically this fee has run into the hundreds of millions of dollars.  The advisor typically determines its value (internalization fee), and than has the REIT pay for a third party "fairness" opinion that confirms the value.  Internalization fees have been under pressure for several years and typically trigger lawsuits from angry investors, the defense of which is paid for by the REIT.   (No comments, please, on Leo Wells $170 million internalization fee.   Although it has received the most press, it wasn't the most egregious internalization fee (other non-traded REITs had higher internalization fees both in term of dollar size and as a percentage of equity raised), it wasn't $170 million, and Leo Wells didn't pocket the entire amount of the internalization fee.)   I hope that ARCT's high-profile move to waive the internalization fee will put an end to this fee once and for all.

ARCT is not the first non-traded REIT to waive internaliztion fees.  Healthcare Trust of America waived its internalization several years ago when it internalized its advisor.  It too has filed an S-11 but has not yet listed on an exchange.   The large stock grants HTA keeps bestowing on its executives, to me, has made a joke of its ballyhooed internalization fee waiver.

ARCT will pay its advisor a 15% Subordianted Incentive Listing Fee (promote), which only gets paid if ARCT's stock trades above $9.81 per share 180 days from listing.  The S-11 desecibes the listing fee as follows:

"In connection with the listing of our common stock on NASDAQ, ARC or its affiliate will be entitled to a subordinated incentive listing fee equal to 15% of the amount, if any, by which (a) the market value of our outstanding common stock plus distributions paid by us prior to listing, exceeds (b) the sum of the total amount of capital raised from stockholders during our prior continuous offering and the amount of cash flow necessary to generate a 6% annual cumulative, non-compounded return to such stockholders. For this purpose, (i) the market value of our common stock will be calculated based on the average market value of the shares issued and outstanding at listing over the 30 trading days beginning 180 days after the shares are first listed."

Most, if not all non-traded REITs have a similar incentive listing compensation feature, but I have tended to gloss over it as few sponsors ever were in a position to earn it.  ARCT, according to an article in InvestmentNews, expects its stock's offer price upon listing to be $11.50.  ARCT's listing price is obviously unknown at this time, and its underwriter won't set a price until right before ARCT share are listed.  Once ARCT is listed its price will vary daily depending on the market.  ARCT's advisor gets its listing fee if, after 180 days,  the previous thirty-day average stock price is above $9.81.  If ARCT is able to execute its business plan and the stock trades above its original $9.81, it makes the loss of the internalization fee much less painful.   ARCT management has an incentive to perform because the higher ARCT's stock price, the more money that is paid to the advisor.   As investors make money so does ARCT.   The S-11 states that for each $.25 increase in ARCT stock price, the incentive listing fee will increase by $6.7 million.  The REIT will pay the listing fee, if any, in the form of a non-interest bearing three-year note.

Don't worry about bumping into ARC executives at the poorhouse due to a lack of internalization fee.  Upon listing, ARCT's chairman has 934,159 shares (received in stock grants from the REIT) that fully vest, and at $11.50 per share target price this is more than $10.7 million.  ARCT's president will have 212,370 shares vest upon listing, which at $11.50 is $2.4 million.  Other executives have shares that will vest upon listing.

The way I read the S-11 is that all ARCT shares will immediately be liquid upon listing.  This is a departure from recent non-traded REIT listings and filings where share releases to investors were deferred and provided liquidity over extended periods, typically twelve to eighteen months.  Immediate liquidity is favorable to investors, and hopefully the short listing period will inhibit unnecessary sales and downward pressure on prices.  ARCT is having a short-term tender offer period to help defuse sale pressure.  Any financial advisor that recommends selling ARCT shares to "reinvest" in another non-traded REIT is doing so only to earn another commission.

If ARCT trades at a premium to the $10 price investors paid for their shares it will be quite a coup for ARC management and, I suspect, a boon to its other non-traded REITs still in their offering period.   It will put pressure on other non-traded REIT sponsors to try and replicate the process - fast listing and working for the promote.  A successful listing (stock price trading at premium to the price investors paid for their shares) should kill the internalization fee for future non-traded REIT listings.

Mind Boggling

Apple's stock broke $500 per share yesterday.  This Tech Crunch blog post may explain why.  In 2007, Apple's emerging market sales were $1.7 billion.  In 2011, emerging market sales were $22 billion, and Apple CEO Tim Cook says Apple is "only on the surface" in emerging markets. 

BDC Scrutiny

InvestmentNews had an article yesterday on regulatory interest in Business Development Companies (BDCs).  This is not a shock giving the amount money flowing into this sector, especially to Franklin Square's BDC.  People need to remember that BDCs are high yield investments with non-credit borrowers.  Non-credit doesn't mean bad credits.  BDCs should be viewed like junk bond funds, not some newly discovered income-generating nirvana. 

Name Change and an Objective Change

CNL Properties Trust today announced that it not only changed its name, but its investment objectives, too.  It is now CNL Healthcare Trust, and will focus on:

The real estate investment offering intends to build a portfolio containing senior housing facilities and a range of healthcare properties, potentially including assisted living and memory care facilities, medical office buildings and continuing care retirement communities as well as it may also acquire other income-producing assets.

The REIT previously was targeting lifestyle and lodging assets, in addition to senior housing.  The REIT specified its first property acquisitions in late December 2011, a portfolio of five senior housing properties, but this transaction has not yet closed.

CNL Healthcare Trust directly enters the competitive healthcare non-traded REIT market, and will compete for assets with American Realty Capital Healthcare Trust and Griffin-American Healthcare REIT II.  Other non-traded REITs seem to keep buying healthcare assets, too, even though healthcare is not their primary target asset class.  In addition, Healthcare Trust of America is still a presence in the market place.

Name Change

American Realty Capital II, LLC, the sponsor of nine non-traded REITs, has changed its name to AR Capital, LLC.  Here is yesterday's press release I saw on my Google News feed.  I like the new name better.  I have always been confused about the "II," and wondered what ever happened to the "I."

Natural Gas Reverse Stock Split

Here is an interesting post on the Financial Times Alphaville blog, on natural gas ETF, United States Natural Gas Fund (UNG).  Because of the low price of natural gas, the EFT is going to have a four-for-one stock split to boost the price of the EFT.  

Atlanta Foreclosure

Here is a good article from Bloomberg on the foreclosure of the Bank of America Tower in Atlanta.  It is the tallest building in the South, and while completely trivial, the tallest building to face foreclosure since the credit market collapsed in 2008.  The article is full of good facts, not only about Atlanta, but also about CMBS.  I didn't know the information in this paragraph:

It’s (Atlanta) now squarely in the bust category with the highest rate of late payments for loans on offices bundled into bonds among the largest U.S. metropolitan areas, at 25.3 percent, according to data compiled by Bloomberg. That’s increased from 10.4 percent a year ago and is more than triple the 7 percent national rate. The rate for payments 60 days late or more was higher than Cleveland at 23.4 percent and Phoenix at 23.3 percent, the data show.

The property was purchased in 2006 for $436 million, the $363 million loan matured in December, and the property was appraised last March at $202 million.