Not Helping

There is plenty of information to analyze with American Realty Capital Properties' (ARCP) disclosure yesterday of accounting errors.  This afternoon, InvestmentNews published a reckless, red herring of an article that did not advance the analysis.  The article's headline states "National Planning Holdings puts kibosh on ARC nontraded REIT sales."  National Planning Holdings represents four broker dealers, but it was not until the fifth paragraph that the article disclosed those four broker dealers only have selling agreements with one ARC product, Phillips Edison - ARC Grocery Center REIT II.  With all the news surrounding ARCP's accounting issues, it's pathetic that a temporary suspension of one selling agreement is InvestmentNews' lead story.

National Planning Holdings has also prohibited its reps from soliciting trades for other AR Capital listed companies.  In its haste to publish this afternoon's story, InvestmentNews didn't even have time to look up one of the securities National Planning Holdings is barring, ARCPP, which is ARCP's preferred stock.  Irresponsible.

There were two news items today more relevant to ARCP than the suspension of selling agreements for one non-traded REIT.  It is being reported that the SEC is to open an inquiry into ARCP's accounting, and that ratings agencies S&P and Moody's are re-evaluating ARCP's credit ratings.  In the short-term, a cut in ARCP's credit rating could lead to higher borrowing costs.  Bloomberg attributed ARCP's stock decline today to this fear.  ARCP is currently rated Baa-3, one level above a junk rating, and its preferred stock has a rating of Ba1, the highest junk rating.

Come on InvestmentNews, you are better than this afternoon's fear mongering article.

Yuck Factor

Here is a Bloomberg article from last week on a unit of insurance giant AIG that is suing a life settlement company.  Life settlements are are described in the article:

In such deals, called life settlements, an investor buys insurance policies from individuals and pays the premiums until they die, when the investor collects the payout. The arrangement becomes less profitable for the investor the longer the person survives.

The division of AIG, Lavastone, hired a life settlement company, Coventry, to buy life insurance policies on its behalf.  The AIG unit is suing Coventry because it bought the life insurance policies cheaper than it knew AIG would pay for the policies and then sold the policies to AIG at a mark-up.

Let's look at this closer:  An insurance company, AIG, forms a division to buy life insurance policies cheap so it won't have to pay the full face amount of the insurance policy when the insured person dies.   "Let's pay $.20 now so we don't have to pay $1.00 later."   AIG had no moral problem buying insurance policies from old or sick people at deep discounts to avoid having to pay the full face value of the insurance, but it gets mad and sues when it found out it paid a deep discount plus a little more. The article didn't state whether Coventry was tasked to buy just AIG policies or could buy any available insurance policies, but I'm sure AIG wanted Coventry to buy AIG policies.  Either way, I don't have much sympathy for AIG.

Life settlement is not a pretty business.

Friday Hijinks

Strategic Storage Trust announced big changes Friday afternoon, September 5, 2014.   It changed its name to SmartStop Self Storage, Inc. and became self managed. As part of the self-management process, SmartStop, through its operating partnership, acquired the operating assets of Strategic Storage Holdings, LLC (SSH), which is the sole member in several affiliated entities.  SmartStop is not, apparently, acquiring its sponsor, Strategic Capital Holdings.  Through SSH, SmartStop expects to receive advisory and property management revenue from the advisors to two REITs in the early stages of their capital raising period, Strategic Storage Growth Trust, Inc. and Strategic Storage Trust II, Inc.

SmartStop acquired SSH's assets for $18 million in cash plus 773,395 units of limited partnership in the REIT's operating partnership.  If the REIT's current $10.81 per share value estimate is used, this puts the SmartStop's cost to acquire the affiliates at $18,000,000 in cash plus $8,360,400 (773,395 units times $10.81), or $26,360,400.  The 773,397 units earn the $.70 per share dividend, or $541,378 per year.  SmartStop had $23.7 million of cash on its balance sheet at June 30, 2014, and the $18 million represents big portion of that reserve. 

In addition, as part of the self-management process, SmartStop granted operating partnership units and Class B operating partnership units to the former advisors of several Strategic Storage entities. The total amount of operating partnership units and Class B units was 1,624,134, which at $10.81 per share is an additional $17,556,889.    The Class B units don't earn distributions until converted to operating partnership units if SmartStop's stock price reaches certain thresholds.  All the operating partnership units earn SmartStop's $.70 per share distribution, which is worth $554,911 per year.

The annual distributions on the newly granted shares total almost $1.1 million per year, a nice yearly stipend. 

SmartStop's letter to investors - which, of course, didn't disclose the price the REIT paid for SSH's assets, you need to go to a filing to find this information - states that the transaction is accretive to the REIT's earnings.  Excellent, I would hope so.  The way SmartStop has historically overpaid its distribution it needs an accretive acquisition.  Seriously, this accretion must be based, in large part, on sales projections and related fee earning potential for the two new REITs.  Both REITs are off to slow equity raises, so I suspect the equity raise projections are more aggressive than actual historical results.   One of the two REITs is private, although it has filed an S-11 to go public, and the second is public, Strategic Storage Trust II.  Through August 2014, Strategic Storage Trust II  had only raised $9.5 million in equity since starting its offering in early January 2014, an inauspicious start.  To its credit, Strategic Storage Trust II did raise $5.5 million in August, its best month since it started its offering.  I don't know how much the private placement has raised.

In the September 5, 2014, investor letter, SmartStop said its two new REITs have $172 million of property under contract on which it can earn fees.  I'd caution that a property under contract is not the same as owning the property.  I know credit criteria has eased in recent years, but you'll still need some fancy financial engineering to buy $172 million of property with only $9 million of equity.  The two REITs need to close the transactions before SmartStop starts to earn fees related to the properties.

There is much about this deal I don't understand.   I am not clear on exactly what SmartStop bought and what it didn't buy.  I don't know the impact of buying operating assets compared to buying entities outright.  I am not sure whether SmartStop bought the SmartStop brand or just the rights to it, and if that is the same thing, or if owning the brand even has any value.  I do not know if worrying about whether SmartStop owns the brand is even a worry.  I do not know when the transaction becomes accretive.  I do know the REIT is now paying out an additional $1.1 million in distributions on all the operating partnership units it issued whether the transaction is immediately accretive or not, and, that after paying out $18 million in cash SmartStop has limited reserves to continue subsidizing its already overpaid distribution.  I am not sure how the value of the transaction was determined.  I am not sure how, if at all, the transaction will impact a liquidity event.  I do not know why I have not read about this deal in any financial press.

Investors were not asked to vote on this $44 million transaction, which doesn't shock me.  I am an optimist at heart, but the pit in my stomach grew as I wrote this post.

I have copied a section from SmartStop's 8-K filed on September 5, 2014, on what SmartStop is purchasing to see whether anyone can make more sense of it:

On September 4, 2014, SmartStop Self Storage, Inc. (formerly known as Strategic Storage Trust, Inc.) (the “Registrant”) and the Registrant’s operating partnership, SmartStop Self Storage Operating Partnership, L.P. (formerly known as Strategic Storage Operating Partnership, L.P.) (the “Operating Partnership”), entered into a series of transactions, agreements, and amendments to the Registrant’s existing agreements and arrangements (such agreements and amendments hereinafter referred to collectively as the “Self Administration and Investment Management Transaction”), with Strategic Storage Holdings, LLC (“SSH”) and the Registrant’s advisor, Strategic Storage Advisor, LLC (the “Advisor”), pursuant to which, effective as of August 31, 2014, the Registrant acquired the self storage advisory, asset management, property management and investment management businesses of SSH. SSH is the sole member of the Advisor and Strategic Storage Property Management, LLC (the “Property Manager”). The Advisor had been responsible for, among other things, managing the Registrant’s affairs on a day-to-day basis and identifying and making acquisitions and investments on the Registrant’s behalf. As a result of the Self Administration and Investment Management Transaction, the Registrant is now self-managed, succeeds to the advisory, asset management and property management arrangements with two additional REITs, Strategic Storage Trust II, Inc. (“SST2”) and Strategic Storage Growth Trust, Inc. (“SSGT”), and has the internal capability to originate, structure and manage additional investment products which would be sponsored by the Registrant.

SSH Contribution Agreement

On September 4, 2014, the Registrant and the Operating Partnership, as Contributee, and SSH, as Contributor, entered into a Contribution Agreement (the “SSH Contribution Agreement”) whereby, effective August 31, 2014, the Operating Partnership acquired substantially all of SSH’s operating assets, including (a) SSH’s 100% membership interests in (i) the Property Manager, (ii) Strategic Storage Opportunities, LLC (“SSO”), (iii) Strategic Storage Realty Group, LLC, the parent company of the advisor and property manager for SST2 and SSGT, respectively, and (iv) Strategic Capital Markets Group, LLC, which owns a 15% non-voting equity interest in Select Capital Corporation, the Registrant’s former dealer manager and the current dealer manager for SST2 and SSGT, (b) all equipment, furnishings, fixtures, computer equipment and certain other personal property as set forth in the SSH Contribution Agreement, (c) all intellectual property, goodwill, licenses and sublicenses granted and obtained with respect thereto (including all rights to the “SmartStop^®” brand and “Strategic Storage” related trademarks), (d) all of SSH’s Software as defined in the SSH Contribution Agreement, (e) all of SSH’s processes, practices, procedures and workforce (including a fully integrated operations team of approximately 300 self storage and other professionals), and (f) certain other assets as set forth in the SSH Contribution Agreement, in exchange for $18 million in cash and 773,395 units of limited partnership in the Operating Partnership (“OP Units”).

The Quiet Liquidity Event

Liquidity events for non-traded REITs have become so routine that Tuesday's announcement that Cole Corporate Income Trust (CCIT) is being acquired by Select Income REIT (SIR) seemed a non-event.  CCIT investors can choose to take $10.50 per share in cash or receive .36 shares of SIR stock for each CCIT share.  Neither the cash option or the stock option can exceed 60% of the total.  The merger values CCIT at $3 billion and is expected to close in early 2015.

The Wall Street Journal's article on the transaction is worth reading, and here is the Bloomberg article on the deal.  American Realty Capital Properties / Cole Capital's press release on the transaction notes that $.20 per share is being paid for incentive fees and transaction costs.  I like this disclosure, as many of these non-traded REITs' liquidity events involve fees to their sponsor firms.  I have not seen the incentive fees so clearly disclosed before and would like to see these listed on all future liquidity events.

Complacency is never good.  Non-traded REITs are long-term, illiquid investments, and liquidity events should not be viewed as a regular occurrence.  The market has favored liquidity events for a few years, but this has not always been the case, and markets can change fast.

Speaking of liquidity events, I was on vacation when the NorthStar Realty Finance (NRF) agreed to acquire Griffin-American Healthcare REIT II in a $4 billion transaction.  By the time I got back to work most of the news on the deal had been out for more than a week making any thoughts I had on the deal stale.  I am still watching for updates and will comment as appropriate.

Glad That Passed

Here is a Bloomberg article on the rebound in junk bonds after a brief sell-off in late July and early August.  Yields on junk bonds have dropped to 5.54%, well below their recent high of 6.01% on August 1.  For a few days there I thought the market had come to its senses and was adding a healthy risk premium to junk bonds.  I guess not.

Note Restructure

InvestmentNews' Bruce Kelly has a good article out this afternoon on the Thompson Note Restructure.  I've had the (dis)pleasure of reading the restructure plan and it affirms my opinion that private notes are tricky, tricky deals.

Kite Completes 1-For-4 Reverse Split

Kite Realty (KRG), which completed its merger of Inland Diversified in early July, finalized its 1-for-4 reverse stock last week.  Investors who originally paid $10.00 per share for their Inland Diversified shares received 1.7 KRG shares in early July, and then these shares were subject to last week's reverse split.  The pre-split breakeven price of KRG's stock for an original Inland Diversified investor was $5.88 ($10.00 divided by 1.7).  The new split-adjusted breakeven price is $23.52, by my calculations ($5.88 times 4).

Today, August 20, 2014, KRG closed at $26.13, or the equivalent of $11.11 to an Inland Diversified investor.

Dented Projections

In the 1990s I sat through several Harry Dent presentations at various financial conferences.  Back then, touting one of his books, Dent predicted the Dow reaching 35,000.  In a reversal, he is now warning of a Dow 6,000 - he has another book to sell!  This CBS Money Watch article from 2013 shows how wrong Dent's guesses have been since the '90s.  Dent is about as worthless as pessimist Peter Schiff.  They can't even prove the saying that a broken clock is right twice a day, because apparently they are broken digital clocks, which are never right.   Together, you can call their speculations dented pieces of schiff.  

Multifamily Starts and Completions

The monthly housing numbers vary widely. According to a Reuters' article on today's housing figures:

Groundbreaking surged 15.7 percent last month to a seasonally adjusted annual 1.09-million unit pace, the Commerce Department said on Tuesday, snapping two straight months of declines.

It is hard to get a good read on housing through one month's data.   Calculated Risk has two good article on today's figures.  The first, here, summarizes the housing report, and the second, here, gives more insight, and both articles put the housing figures into a wider context.  After reading the two posts I am optimistic about housing's continued strength. 

The data on multifamily starts and completions was interesting, especially after reading and posting Monogram Residential Trust's valuation assumptions yesterday.  Calculated Risk has the following graph:

Multifamily construction starts are approaching levels not seen since the late 1980s.  The added supply have to put pressure on cap rates and rental growth rates as multifamily owners compete with one another.

Monogram Q&A

The Monogram Residential Trust Q&A regarding its recent valuation is worth a read.  It is eye-popping.  This blog has discussed valuation methods before and is not going to regurgitate the topic again.  But it is worth noting that Monogram determined its value, while Duff & Phelps was used to verify Monogram's valuation assumptions and methodologies. 

Monogram valued its operating properties using forward cap rates and rental growth assumptions based on various markets across the country.  Rental growth rates ranged from 1.7% to 4.9%, with an average of 3.4% annually.  Cap rate assumptions ranged from 5.0% on the high end to a low of 4.2%.  Properties under development were valued using similar methodologies: 

These inputs included construction costs, completion dates, lease up rates, rental growth rates, operating expenses, occupancy, capital expenditures, exit capitalization rates, and discount rates.

The question I have is how does this REIT come up with a value of only $10.41 per share when it uses forward projections with rental growth rates over 3% and cap rates under 5%?

Can't Tell The Players Without A Program

Dollar General, Dollar Tree and Family Dollar Stores.  I'll admit, it is hard for me to tell the three discount retailers apart, but look at the portfolio of any retail-focused, net lease real estate investment trust and you'll likely see properties leased to one or more of the three companies.  Too add to the confusion, Dollar General is in a bidding war against Dollar Tree to buy Family Dollar Stores.  To help poor saps like me, all three companies should merge and call the new company Super Dollar. 

Tweet Worthy

I need a twitter account for this blog because some things I read are only worth the 140 characters of a tweet.  In an email today pushing its annual conference, REISA highlighted a session called "The Anatomy Of A Successful Oil and Gas Deal."   Besides hosting a fantasy session, apparently REISA forgot that its full name is Real Estate Investment Securities Association.  A look at the companies sponsoring this year's REISA event includes several oil and gas companies and the sponsor of a dodgy note program. (The notes are backed by life insurance policies - i.e. people have to die to pay interest and principal.)  Good times.

Monogram Seeks To Join Liquidity Bandwagon

Monogram Residential Trust, the formerly named Behringer Harvard Multifamily REIT I, announced yesterday that it plans to list its shares on a national exchange.  Like the Inland American disclosure earlier in the week that it is spinning off its lodging properties, the Monogram news was vague on specifics.  Monogram's board has authorized the start of "the process of exploring a potential listing on a national exchange."  The REIT's board has apparently explored various liquidity options and has decided that a listing provides the best opportunity for investors. 

The REIT made the decision to terminate its share repurchase program and its distribution reinvestment plan even though the listing timing is not clearly defined.  An open-end listing date combined with stoppage of the share repurchase program is an invitation to mini-tender firms to step in and offer low-ball bids for now completely illiquid shares. 

Separately, Monogram announced a new estimated per share value of $10.41 per share, an increase from the $10.03 per share as of March 1, 2013.  I should not have to state this but will any way: remember, the $10.41 is the REIT's estimate per share only and any listing price, or mini-tender offer, will likely vary from this price.

A successful listing - any price near $10.00 per share - for Monogram would not only be positive for investors, but for Behringer Harvard, too.

No Verruca Of A Deal

It was just a year ago when the $10 billion Inland American REIT announced it was selling $2.3 billion of properties to various American Realty Capital REITs.  Inland American didn't distribute any sale proceeds to investors from that sale.  Inland American announced earlier this week it was forming a separate, publicly traded company for all its lodging assets.  This time, Inland American investors will receive shares in the new company, while retaining shares in Inland American.

The new lodging company is called Xenia Hotels & Resorts, Inc., with a symbol XHR.  The spin-off is expected to be completed in four to eight months and include nearly fifty properties.  Key details, like whether investors are going to have their shares locked up for a certain period, or what the estimated value of the lodging transaction is to an Inland American investor, have not been finalized and were not in Inland American's filing or this InvestmentNews article.  Inland American is focusing on three main property types: lodging, multi-tenant retail and student housing. 

I am glad Inland American picked such an easy name for its new company.  Here is the definition of xenia:

xenia |ˈzēnēə, -nyə|
noun Botany
the influence or effect of pollen on the endosperm or embryo, resulting in hybrid characteristics in form, color, etc., of the derived seed.

After reading that crazy definition of a xenia, I am reminded of the goof name Veruca Salt from Roald Dahl's Charlie and the Chocolate Factory.

BREAKING NEWS - INTERVAL FUNDS ARE FUNDS-OF-FUNDS

DATELINE: AUGUST 13, 2014, ALTERNATIVE INVESTMENT UNIVERSE

THIS BLOG HAS DISCOVERED THAT INTERVAL FUNDS ARE FUNDS-OF-FUNDS.  INTERVAL FUNDS RAISE EQUITY TO INVEST IN OTHER INVESTMENT FUNDS, THE DEFINITION OF A FUND-OF-FUNDS.   INTERVAL FUNDS HAVE TWO LAYERS OF FEES... FEES AT THE INTERVAL FUND LEVEL AND FEES AT THE INVESTMENT FUND LEVEL.  ANY RESEARCH OR DUE DILIGENCE REPORT ON INTERVAL FUNDS SHOULD DISCLOSE THIS DATA.

IN A RELATED STORY, THIS BLOG HAS LEARNED THAT THERE IS NOTHING WRONG WITH FUNDS-OF FUNDS.

Cracks in the Credit Facade

Here is a cheery Bloomberg article to start your day.  It goes into detail on a few pending CMBS offerings and how issuers are having to boost yields to get their bonds sold, as investors are worried about credit quality and want to get paid for added risk.  Gee, what a concept.  Like the article I linked to yesterday, there are plenty of facts in this article and I don't want to excerpt key points out of context. 

I will note this quote, though:

Property values in the largest U.S. cities have surpassed their 2007 peaks, encouraging demand, after plunging as much as 42 percent in the aftermath of the credit crisis, according to Moody’s/RCA Commercial Property Price Index .

I have read plenty of articles in recent months about the drop in lending standards.  Investors' search and desire for yield has made them less concerned about credit quality.  It seems a welcome push back has begun.  It needs to spread beyond real estate.  

Big Deal?

I have been away for a week or so recharging the batteries and sharpening my pencil.  I just saw this Reuters article on regulator scrutiny of private equity leveraged loans, which I suspect includes loans made by business development company loans, too.  This seems like a big deal to me and an issue worth watching.    I'm not going to excerpt any portions of the article because no passage makes sense out of context.  The article is short and worth a read.

Gibberish With A Dash Of Wisdom

This InvestmentNews article from yesterday has me scratching my head.  It's an opinion piece, loose on facts.  The article is written by the manager of the Resource Real Estate Diversified Income Fund (RREDX), an interval fund that invests a portion of its assets in non-traded REITs.   I am going to address a few points from the article.

This sentence early in the article is an understatement:

The best type of liquidity event is when nontraded REIT investors tend to make a profit on their initial investment.

 Duh.  I'm not sure what I can add to this bit of brilliance.

This specious passage troubled me:

Most liquidations happened in one of three ways:
1) An IPO into the REIT public market
2) A sale to an affiliated publicly traded REIT
3) A sale to a REIT sponsor that is a publicly listed company

Very few non-traded REIT liquidity events involve an Initial Public Offering.  An IPO as part of a listing has a stigma attached to it and indicates a REIT is in financial difficulty.  Does anyone remember Inland Western, now Retail Properties of America's (RPAI) IPO and listing?  An IPO involves raising new equity capital - that is the IPO part - and the few non-traded REITs with IPOs attached have locked up existing shareholders.  This happened with the former Wells Timberland (now Catchmark Timber Trust (CTT)) and BlueRock Residential Growth (BRG). 

A listing of shares not involving an IPO is a more common liquidity event.  Examples include American Realty Capital Trust, American Realty Capital Healthcare Trust (HCT), American Realty New York REIT (NYRT), United Development Funding IV (UDF), Cole Credit Property Trust III (listed as Cole Real Estate Investments)), Wells REIT II (Columbia Property Trust (CXP)), and CB Richard Ellis (Chambers Street (CSG)). 

The second point, the sale of a non-traded REIT to an affiliate requires a listed affiliate, which only applies to a few sponsors.  American Realty Capital, through listed American Realty Capital Properties (ARCP), and WP Carey (WPC) have used this method.  NorthStar Realty Finance (NRF) has the potential to use this strategy, but it has not to date.  Inland has several listed REITs but has not used these traded companies to buy or merge with any other Inland non-traded REIT.

The third point, sale of a non-traded REIT to a listed REIT sponsor, is even more tenuous.  The only example that I can think of is ARCP buying Cole Real Estate Investments last fall.  If the rumored NRF acquisition of Griffin-American Healthcare REIT II ever happens, that would be the second example.  A non-sponsor listed REIT buying a non-traded REIT is more common.  Kite Realty (KRG) purchased Inland Diversified earlier this year and Spirit Realty (SRC) acquired Cole Credit Property Trust II in 2013.  Both acquisitions were positive for the buyers.  Inland sold its second REIT to Developers Diversified (DDR) back in the mid-2000s.  There have been several post-listing acquisitions for former non-traded REITs, too, with Realty Income (O) acquiring American Realty Capital Trust after it listed, and now American Realty Capital Healthcare Trust (HCT) is being acquired by Ventas (VTR). 

If you look at the logic behind point three, it becomes a mute point.  Buying a competitor's non-traded REIT makes that competitor look good by giving it an instant track record and liquidity.  It makes no sense for a sponsor to give this advantage to competitor.  Plus, sponsors make big money during the capital raise and investing period, not so much from managing invested assets.  From a sponsor perspective, it's a poor business decision to buy a fully invested company after this one-time, money making opportunity is gone.

I am sick and tired of the fear-mongering trope about rising interest rates.  This article speaks as if rates have already gone up and stocks have tanked.   The article states:

We have also seen a decrease in the valuation of many of the net lease publicly traded REITs, the asset type that represents approximately two-thirds of the nontraded REIT market, due to concerns about higher interest rates.

Whether or not this is an opinion piece, the statement is wrong.  Check the stock charts of O, SRC, WPC and ARCP.  With the exception of ARCP, all are at, or not far from, 52-week highs, and ARCP is trading strong.  Yields on the ten-year Treasury are below 2.50%, and are down about 50 basis points from the start of the year.  Yes, some day interest rates are going to increase, but it has not happened yet.    

I'll finish on a positive note.  The following statement alone is worth reading the article:

Instead, investors should be prepared to stay in non-traded REIT programs longer and focus on the attractiveness of the investment, rather than an early exit.

Non-traded REITs are long-term investments, not short-term flip vehicles.  Recent liquidity events have been positive for investors, sponsors, and brokers.  I hope it continues.  But any investor in a non-traded REIT should be prepared to hold their investment for the maximum time stated in the offering prospectus, if not longer.

North Dakota Oil Boom

Here is a short article worth reading from the Fivethirtyeight blog.  It discusses the boom in North Dakota's oil production, primarily in the Bakken Shale formation.  Besides the two startling graphs imbedded in article, this passage stood out:

The issue isn’t whether North Dakota will run out of oil. There’s little doubt that the Bakken Shale, North Dakota’s main oil-producing reservoir, contains billions of barrels of crude. The question is about getting it out. A well’s production rate — how much oil it pumps in a given amount of time — falls quickly, and wells drilled into shale rock like the Bakken decline especially fast, as much as 70 percent in the first year. That means oil production is a treadmill: Companies have to keep drilling just to keep production flat. The more they produce, the more they have to drill to keep up.

The 70% first year decline is incredible.  To help some of the depletion, drillers, through technological advances, have increased well productivity.   Wells on line for at least a month produced 116 barrels a month in 2007, now produce over 500 barrels a month.  

Sloppy Work

Recently I read an article and investment report on two finance companies that pay sizable current distributions and interest, all of which are supported by accrued revenue.  Accrued revenue or accrued interest is not paid until an investment or loan matures.  For example, if a company makes a two-year, $1,000,000 preferred equity investment with a 12% accrued interest, in two years the company will receive back the $1,000,000 in principal and $240,000 of interest.  There is a lag before a company realizes accrued revenue. 

If a company is paying a current distribution that is backed by accrued revenue, cash has to come from somewhere until the accrued revenue is realized.  This typically is either through borrowing or equity.  Eventually, as a finance company grows and matures, its flow of realized accrued investments should exceed the amount it pays in distributions. 

This is not yet the full situation in the two finance companies where 100% of their investments are accrued, and their current distributions are being paid through reserves, equity, borrowings, and in one company, some operating cash flow (realized accrued income).  Neither the article nor the investment report noted the accrued income, the time differential between when revenue is booked and when cash is realized, or addressed how the companies were paying current distributions.  This annoys me and it is sloppy work.   I believe the authors did not fully understood the companies they were writing about, which is bad.

There is nothing wrong whatsoever with finance companies that originate or own accrued investments.  If a finance company makes accrued investments with equity or borrowings that require current distributions or interest payments, how the company supports those current distributions or interest payments is important information.  Unfortunately, you would not get this information from the two pieces I read.

Filling A Void

I noted at the end of a post last week that Griffn-American Healthcare REIT II's shareholders are being solicited by a mini-tender firm.  The firm is offering to buy shares at a strong price compared to the REIT's original offer price.  Griffn-American REIT II is not the only non-traded REIT where shareholders are being approached by the mini-tender firms.  Signature Office REIT, the formerly named Wells Core Office REIT, and Strategic Storage Trust are also being targeted by mini-tender firms.  Below is a table with the offer price, tender price, and discount for the three tender offers:

Non-Traded REIT	Orig. Offer Price	Tender Offer	Discount to Offer
G-A Healthcare II	$10.00 to $10.22	$10.00	0.0% to 2.2%
Strategic Storage Tr	$10.00 to $10.79	$7.25	27.5% to 38.8%
Signature Off. REIT	$25.00	$16.00	36.0%

 
All three of the non-traded REITs have terminated or suspended their share repurchase plans as they seek liquidity events, which have spurred the mini-tender firms.  These companies are annoying, to say the least, to non-traded REITs.  The mini-tender firms are money managers - not altruists - looking to acquire shares at cheap prices, not necessarily pay market prices, but they are stepping in to provide a limited form of liquidity where none is available.  The cliche is buyer beware, but in this case, it is seller beware.   

Liquidity Events and Hyperbole

I re-read the Bruce Kelly article I linked to earlier in the week.  The article stated that there were only two liquidity events in the first half of 2014.  Bruce missed a few.  Here are the liquidity events I know of in the first half of 2014:

Liquidity Events First Half of 2014
Fund	Month	Original Equity (Billions)
ARC Trust IV	Jan	$1.7
CPA 16 Global	Feb	$1.9
BlueRock Resid.*	Feb	$-
ARC Healthcare	April	$1.7
ARC New York REIT	April	$1.7
UDF IV	June	$0.6
FSIC	April	$3.0
TOTAL		$10.6

In addition to ARC Healthcare and ARC New York REIT, the first half of 2014 saw ARC Trust IV complete its merger into American Realty Capital Properties (ARCP), CPA 16 merge into WP Carey, and the listings of Blue Rock Residential Growth* (BRG) and UDF IV (UDF).  I included the April listing of the first Franklin Square business development corporation, Franklin Square Investment Corp (FSIC), because while not a REIT it was a non-traded investment that provided a liquidity event. 

The strange part of the Kelly article was the Inland executive gloating about Inland Diversified's completed merger with Kite Realty:

The deal has been one of the most successful for nontraded REIT investors in the recent past, Mr. Sabshon said.

He noted that on July 2, the first full trading day for the Inland Diversified/Kite merger, Kite closed at $6.40. At an exchange rate of 1.7, that translates to an Inland Diversified exit value of $10.92, he said.

Excluding nontraded REITs that were purchased by related or affiliated REITs, a common industry practice, the Inland Diversified merger represents the highest nonaffiliated transaction exit price in two years, Mr. Sabshon said.

Yes, Inland Diversified's sale to Kite Realty was a successful liquidity event.  No, it was not the most successful listing of the past two years.  Does anyone remember the Cole Credit Property Trust III listing a year ago?  I believe there was some controversy surrounding this listing, but it opened at $11.50 per share.  The Inland executive's arbitrary exclusion of affiliated liquidity events makes no sense.  Is cash from an affiliated liquidity event worth less than cash from a non-affiliated liquidity event?  The CPA 16 and ARCT III liquidity events were with affiliated entities and traded at values higher than Inland Diversified's 9% premium.  I am taking nothing away from Inland Diversified's listing and its returns to investors, they are commendable and more than respectable, but let's lower the hyperbole. 

*  BlueRock Residential Growth (BRG) only raised about $23 million of investor equity in its multi-year offer period.  BRG's listing involved an IPO where the original investors received three classes of illiquid Class B shares.  The first B class does not convert to liquid shares until twelve months after the listing, and it'll be two years post-listing until original BRG shareholders are fully liquid.  BRG is a listing but should not be considered a liquidity event.   Its equity raise was so small it would not even show on the table above.

Crap Storm Warning

This afternoon, Strategic Realty Trust disclosed in a SEC filing that it has determined a new net asset value (NAV) of $7.11 per share.  The REIT raised capital at $10.00 per share.  It issued valuation estimates during the offering period that reached $10.60 per share.  This $10.60 per share claim was as recent as early 2013 when it completed its offering period.  The new value represents a 33% decline in NAV in eighteen months, which was during a period of rising commercial real estate values.

This blog talked about Strategic Realty here, where it referenced an InvestmentNews article, and I talked about the REIT's valuation process here. 

This is ugly and someone is going to have to answer some tough questions. 

Starting To Make Sense

I wrote yesterday that I was not going to pay attention to any rumors until they showed up in a Bruce Kelly article.  No sooner than I had posted that comment than I read Kelly's report that NorthStar Realty Finance (NRF) is in talks to buy the Griffin-American Healthcare REIT II.  His story reads as though he sourced it through the same Financial Times article I referenced.  Kelly's article provides a good rundown of recent non-traded REIT liquidity events in addition to NorthStar's potential purchase of Griffin-American Healthcare REIT II.

At first I didn't understand why NRF would spend $3.7 billion to $4.0 billion for a healthcare REIT.  I immediately thought it was a way to combine the NorthStar and Griffin-American non-traded REIT sales platforms.  I have always primarily viewed NRF as a real estate finance company that, to a lesser extent, owned other real estate, including healthcare, manufactured homes and hotels.  Then I read NRF's first quarter 10-Q and the Griffin-American Healthcare REIT II acquisition makes more sense.  NRF hired James Flaherty III in January to build NRF's healthcare business.  From NRF's 10-Q:

In January 2014, NSAM entered into a long-term strategic partnership with James F. Flaherty III, former Chief Executive Officer of HCP, Inc., focused on expanding the Company’s healthcare business into a preeminent healthcare platform (“Healthcare Strategic Partnership”). In connection with the partnership, Mr. Flaherty will oversee and seek to grow both the Company’s healthcare real estate portfolio and the portfolio of NorthStar Healthcare. In addition, the partnership is expected to focus on raising institutional capital for funds expected to be managed by NSAM.

NSAM is the company NRF spun off earlier this month.  NSAM is NRF's asset manager and it or an affiliate will serve as the distributor and advisor for NRF's non-traded REIT business.   Mr. Flaherty is also the CEO and President of NorthStar Healthcare Income, Inc.  In May 2014, NRF acquired a $1.1 billion portfolio of healthcare properties, primarily assisted living and skilled nursing facilities.  NRF now has $1.63 billion of healthcare assets and is seeking to aggressively grow this business, and this explains NRF's interest in the  Griffin-American Healthcare REIT II portfolio.  NRF's first quarter 10-Q is worth a read because it discusses Mr. Flaherty's financial incentives to growth the healthcare business. 

How NRF would finance the Griffin-American Healthcare REIT II acquisition is another consideration, but the rationale for the purchase is clear.

LIBOR Plus ?!?!

When United Development Funding IV (UDF) listed on NASDAQ in early June it offered to repurchase up to $35 million of shares at a price of $20.50 per share.  The tender offer was oversubscribed by about three times, which was not unexpected.  UDF, in a filing last week, disclosed that it is financing the entire share repurchase with a $35 million loan from an entity called Waterfall Finance 4, LLC.  The loan has a one-year term and is due July 2, 2015.  UDF is paying LIBOR plus 9.0%, and interest is due monthly.  LIBOR is currently around .25%, so UDF is paying about 9.25% for the money.  I am snarkless.

Shut Up Already

The Financial Times published another apparent non-story last week.  (Sorry, no link to the story but you can Google it.) This one was on the alleged acquisition by NorthStar Realty Finance (NRF) of Griffin-American Healthcare REIT II at a price tag of $3.7 billion to $4.0 billion.  In late May the same FT reporter, Ed Hammond, had a story that Dividend Capital's Industrial Income Trust was looking to sell itself for $4 billion.  I discussed that article here. 

Nothing has happened yet with Industrial Income Trust, and a week and a half later I've read nothing else on a NRF / Griffin-American Healthcare REIT II combination.  In early May, Griffin-American Health REIT II was subject of a Wall Street Journal article on another impending sale that never happened.  I noted the WSJ article here.  I'm not sure what's going on with these rumors, but suspect they are attempts to drive up merger prices by attracting additional potential buyers.  From now on until Bruce Kelly reports a combination I'm not going to take any story seriously.

Based on data in the May Wall Street Journal article, a price of $3.7 billion to $4.0 billion for Griffin-American Healthcare REIT II would result in share price of $12.63 to $13.66.  If the merger leaks are an attempt to drive the price for Griffin-American higher, whoever is blabbing to reporters should stop.  A price per share range of $12.63 to $13.66 is excellent, especially since the REIT finished its equity raise less than a year ago at prices of $10.00 to $10.22 per share and paid a load of 12% on that equity. 

A NorthStar / Griffin-American Healthcare REIT II merger presents more narrative than was addressed in the short FT article.  Both Griffin and NorthStar operate respected syndication businesses.  Where do these play into the merger, if at all?  A combination of this business would be interesting and have more implications than just a single REIT's liquidity event.

Separately, but tangentially, Griffin-American Health REIT II shareholders are being solicited by mini-tender offers.  The companies that issue these tender offers usually make offers at deep discounts to prices paid by investors for their shares.  The current tender offer price for Griffin-American is $10.00 per share, essentially no discount to the price most investors paid for their shares.

Vacancy Sign Flashing

Here is a Bloomberg article on recent transactions in the hotel sector.  It has been an active sector.  I missed the NorthStar (NRF) news last month that entered into a nearly $1 billion joint venture with Chatham Lodging for forty-seven limited service hotels.  The article lists so many transactions it does not even get into some of the back stories, like how American Realty Capital Hospitality Trust, which is in the early stage of its equity raise, is financing the 126 hotels it is buying from affiliates of Goldman Sachs for $1.93 billion. 

I would point out couple of additions to the article.  First, the terms "limited service" and "select service" seem blurred, but are two distinct categories.  Most of the transactions listed in the article have happened in the limited service category, which include brands like Courtyard, Homewood Suites, and Hampton Inns.  Select service is a lower amenity property and includes brands like Days Inns and Super 8.  Management, marketing, pricing and valuations are different for limited service and select service hotels.

Second, the article points out that:

The U.S. hotel industry has recovered since the financial and real estate market meltdown. Room rates in the first five months of this year hit a record, according to Jan Freitag, senior vice president at research firm STR Inc. This year through May, the average price for a hotel stay nationwide jumped to $113.58 a night, up 4.1 percent from a year earlier, according to Hendersonville, Tennessee-based STR.

And, it notes that the volume of deals (again confusion with the term "select service") in 2013 was the most since 2006.  The article does not mention the impact of new hotel supply.  I believe it was much higher in 2006 than current levels.  This means, in part, that an economically sensitive sector will not have the addition of new supply to contend with, which pressures rates and occupancies, when the economy slows.  Of course, high trading values for hotel properties, strong occupancies and increasing room rates is going to attract hotel developers.

Know The Brand - Part II

InvestmentNews' Bruce Kelly confirms what WP Carey's CEO Trevor Bond said on a conference call last month:  WP Carey has no plans to launch CPA 19 as a follow-on to its previous CPA programs.  Kelly's article is full of good information.

Spain Rising

I have watched for a Spanish economic recovery for no other morbid reason than Spain was hit so hard by the late 2000's credit crisis and recession.  I believe that a Spanish rebound signifies good news for all of Europe.  Spanish unemployment is currently 26% and is not expected to dip below 20% until 2017 according to S&P, which is not encouraging (unless you view the hiring that would cause the unemployment rate to drop six percentage points as positive).  But Spain's economy is improving and it expanded twice as fast as the Euro region in the first quarter (Bloomberg).  Here is a Bloomberg article on the beginning recovery of Spanish residential real estate.  The Spanish economy is still bleak, but appears to be moving in the right direction.

Mind the Debt

I received a comment on an old post over the weekend referencing this Financial Times article (subscription required), which states that Dividend Capital's Industrial Income Trust is looking to sell itself for $4 billion.  The comment said I should not have questioned Industrial Income's 2012 revaluation, which at the time - in the midst of the REIT's offering - valued the REIT at $10.40 per share.  The person who posted the comment calculated that Industrial Income Trust, at $4 billion, was worth $18.50 per share.

I read the Financial Times article and Industrial Income's most recent 10-Q, and unfortunately came up with a value well short of $18.50 per share.  You must remember that while Industrial Income may sell for $4 billion, it has just about $1.9 billion of debt, so the net equity is closer to $2.1 billion.  Here is my math:

Value	$4,000,000,000
Debt	$1,914,691,000
Net Equity	$2,085,309,000
Shares Outstanding	$208,135,000
Equity Value Per share	$10.02

Industrial Income raised $2.1 billion in its offering and through its distribution reinvestment - about what a $4 billion sale would recover after accounting for the REIT's debt. 

Industrial Income's first quarter net operating income was $58,292,000.  If you annualize this figure (multiply it by four) and divide by the $4 billion price tab, you arrive at a cap rate of 5.8%.  The 5.8% cap rate seems rich, but maybe the market is pricing in the REIT's 67% lease turnover before the end of 2019, and the potential to sign new leases at higher rates.   I am surprised that at a 5.8% cap rate Industrial Income doesn't have more equity value than $10.02 per share.    The REIT's initial offering costs and over payment of distributions early in its life are real expenses that must eventually be reflected (deducted) in value.

I think it's great Industrial Income is looking sell for $4 billion.  If it can sell its portfolio of industrial properites at a 5.8% cap rate, it should accept this deal without hesitation.

The Financial Times article had a misstatement.  Industrial Income is not a private company.  It is a non-listed public company. 

(Note that my figures are very rough and are shown for general illustrative purposes not to determine an actual valuation.   The actual share price an investor may receive from any Industrial Income sale would likely vary as there are many more considerations than I have listed that would factor into any sale.)

All Apartments

I have some apartment-related links to post.  First two links are to articles on last week's housing figures, and how multifamily construction is driving residential home construction.  The first is from the New York Times' excellent new The Upshot section.  It states that the improved home construction figures are a result of new apartments being built, not single family homes.  The second is from the FiveThirtyEight blog.  It, too, notes that apartment building makes up a large portion of housing construction growth, but FiveThirtyEight is negative on the implications of this trend to rent for the greater economy.  Both articles are worth reading as smart insights on the housing market.

The Calculated Risk blog provides insight on the apartment market.  It makes this statement:

This favorable demographic (the number 20 - 34 year old people (prime renters) is expected to stay high through 2030) is a key reason I've been positive on the apartment sector for the last several years - and I expect new apartment construction to stay strong for several more years.

New supply will probably increase by 250,000 to 260,000 units this year - and increase further in 2015 since it can take over a year from start to completion for large complexes.  Note: This doesn't include houses converted to rentals - and that is a substantial number in recent years.

This suggests new supply will probably balance demand soon, and that means vacancy rates are probably close to a bottom.

The construction of new apartments, as well as seeing vacancy rates close to the bottom, may mean cap rates are near a low, as multifamily buyers have more options.  This may be one reason Blackstone, which has been a big seller of various real estate asset classes this year, is looking to buy apartments.  Here is a Bloomberg article on Blackstone's new apartment venture, LivCor.  Apparently, Blackstone sees the growing demand and the new supply as opportunities.

New supply will probably increase by 250,000 to 260,000 units this year - and increase further in 2015 since it can take over a year from start to completion for large complexes.  Note: This doesn't include houses converted to rentals - and that is a substantial number in recent years.

This suggests new supply will probably balance demand soon, and that means vacancy rates are probably close to a bottom.
Read more at http://www.calculatedriskblog.com/2014/05/apartments-supply-and-demand.html#rdH8T3zHEXDyhmaf.99

New supply will probably increase by 250,000 to 260,000 units this year - and increase further in 2015 since it can take over a year from start to completion for large complexes.  Note: This doesn't include houses converted to rentals - and that is a substantial number in recent years.

This suggests new supply will probably balance demand soon, and that means vacancy rates are probably close to a bottom.
Read more at http://www.calculatedriskblog.com/2014/05/apartments-supply-and-demand.html#rdH8T3zHEXDyhmaf.99

New supply will probably increase by 250,000 to 260,000 units this year - and increase further in 2015 since it can take over a year from start to completion for large complexes.  Note: This doesn't include houses converted to rentals - and that is a substantial number in recent years.

Read more at http://www.calculatedriskblog.com/2014/05/apartments-supply-and-demand.html#rdH8T3zHEXDyhmaf.99

UDF IV Listing

United Development Funding IV, a mortgage REIT, plans to list its shares on Nasdaq, under the symbol UDF on June 4, 2014.  In a show of optimism for its list price, UDF is offering to purchase up to $35 million of shares through a tender offer at $20.50 per share.  UDF sold its shares to investors at $20.00 per share. 

ARCP Happenings

Yesterday, May 21, 2014, American Realty Capital Properties (ARCP) announced that it was selling its multi-tenant shopping centers to affiliates of private equity giant Blackstone (BX).  Here is a Bloomberg article.  The all-cash $1.98 billion transaction is expected to close withing thirty days.  ARCP had originally planned to spin-off the shopping centers into a separate company.  ARCP plans to use a large portion of the  $2 billion to complete the acquisition of the 500 Red Lobster properties it agreed to acquire last week for $1.5 billion. 

Separately, ARCP filed yesterday to issue 100,000,000 shares of common stock.  Today, ARCP announced that it sold 120,000,000 shares at $12.00 per share, bolstering its balance sheet by an additional $1,440,000,000 before fees.  ARCP plans to use a portion of the proceeds to repay debt.

Stuyvesant Town - Peter Cooper Village

Here is an update to a story I linked to last week.  It looks like the four-year drama surrounding the massive Stuyvesant Town - Peter Cooper Village apartment complex coming to a fast close.  The article is a tutorial in various forms of complex real estate finance.

Know The Brand

WP Carey's (WPC) CEO, Trevor Bond, made an interesting comment on WPC's May 8th earnings call, which I read in the call's transcript.  In response to a question as to whether WPC is planning a CPA 19 (Corporate Property Associates 19), Mr Bond said this (my emphasis):

Well, it's a great question. We have no -- nothing filed now with the SEC and nothing on the works. I think that we like the optionality going forward of having the ability to delay the CPA:19 as long as we need to. We'll think more about that as we get to the end of the investment period for CPA:18. We have a modest amount of capital still left in CPA:17, and so CPA:17 and CPA:18 are co-investing on some deals. And I think that from management's point of view, the risk of not having a CPA:19 tied up is not a problem because we can always shift deal flow toward W. P. Carey Inc. if we're ever in a period where we are out of the market. And I think that would then further our goals of growing our balance sheet because the transactions that worked for the funds are clearly going to be very accretive for W.P. Carey Inc. And so it's something that has -- as we get closer to the end of the investment period for CPA:18, we'll be faced with that decision. I'll also say that now that we focused -- we are focusing on creating new products silos for our investment management platform, the Hotel fund which has been successful to date is one example. We also have an active self-storage business as you know, which is folded into the CPAs, but we could have a separate fund for them. And then we're always considering other product silos with capable experienced sponsors and other product types. And so I think that it's probably better for us to focus more on that type of new product, really, in the medium term, to enhance the value of our platform. And so that will continue to be one of our areas of focus.

So, WPC is thinking of not immediately offering another REIT in its flagship CPA brand.  WPC may just buy properties directly.   I have no doubt WPC, with its $6.2 billion market capitalization, could acquire accretive properites, and do it cheaper than a CPA REIT.   I'm less optimistic about the larger implications to the non-traded REIT industry of this possible WPC product exit. 

Broker / dealers sell WPC products because of its CPA programs and their history of regular income and long-term performance.  WPC's hotel deal has raised a moderate amount of capital, but CPA 18 raised more equity over the last six months than the hotel deal has raised in nearly four years.  Brand is important, and WPC's brand is Corporate Property Associates - which are sale/leaseback REITs -  not a hotel REIT, not a self-storage REIT, and not whatever new product it develops. 

WPC, through its CPA REITs, offers real competition to the ARC / Cole non-traded REIT machine.   WPC now appears ready to cede market share to ARC at a time when quality REIT options are shrinking.  If it thinks it can create new products, or stop selling or delay the next CPA program and maintain market share, WPC is misjudging its brand and the competitive environment. 

Tender Offers - Part II

I noted last week that American Realty Capital Healthcare Trust's tender offer was five times over subscribed.  American Realty Capital's other April listing, New York REIT (NYRT), announced the results of its listing tender offer earlier this week.  The REIT was able to accept all 12.9 million tendered shares, which was just over half the 23.3 million shares the REIT had offered to purchase. 

Reads

It's been a long while since I linked to articles worth reading.  Here are three articles that I've read the past few days that are worth a quick read.

The first is a New York Times article on the 11,000-plus unit Stuyvesant Town - Peter Cooper Village in Manhattan.  I have blogged about this property before, and it's sale from 2006 is still making news.

The second is from Morningstar.com and discusses business development companies (BDCs).  The article is in the form of a Q&A and mainly relates to listed BDCs, but some of the quotes in the article pertain to all BDCs, whether listed or non-traded.

The final article is from the Wall Street Journal and talks about the non-bank banks that are financing real estate.  I only see these firms gaining strength and capital in the coming years.

Ah, A Perk Of Being Listed

Franklin Square Investment Corp (FSIC) the recently listed business development company, filed a $1 billion shelf registration today, which allows the company to raise capital "through the sale of various securities including common stock, preferred stock, warrants, debt securities or subscription rights in one or more future offerings."  FSIC has more financial flexibility now that it's listed, and appears ready to take advantage of it.

Griffin-American Healthcare Bids

Here is a free Wall Street Journal article on the final four bidders for the non-traded REIT Griffin-American Healthcare REIT II.  Bidders include affiliates of other non-traded REIT sponsors, in particular recently listed American Realty Capital Healthcare Trust (HCT) and a division of Northstar (NRF).  The bidding, according to the article, is expected to conclude within two weeks.  The article states:

The investors, mostly retirees and other individuals, paid between $10 and $10.22 a share from 2009 to 2013. Current offers from the four finalists have topped $12.50 a share, according to people briefed on the price, which would put the company's value at $3.66 billion.

At $12.50 per share, the sale would be a success for investors.  (I'm not sure how the article's author knows that most of the investors in Griffin American Healthcare REIT II are retirees.)  I will watch for filings to see how this potential transaction proceeds.

On a separate matter, the article includes good information on non-traded REIT liquidity events and includes this quote:

This year "is going to be something of a litmus test for nontraded REITs, to see if they can exit quickly into the public market," said Scott Crowe, a portfolio manager with Resource Real Estate in New York, a firm that buys real estate and invests in shares of nontraded REITs on the secondary market. "I think [deals] still make sense in places like the health-care space where there's a long history of those companies trading at a premium" to the value of their assets.

The article fails to mention that Resource Real Estate, in addition to investing in non-traded REITs on the secondary market, also offers its own multi-family non-traded REIT.

Tender Offers

Inland American announced last week that it expanded its original $350 million modified Dutch tender offer and accepted tenders for $394 million shares of its stock at a price of $6.50 per share. The original Dutch tender offer was for between $6.50 and $6.10 per share.  This is the first Dutch tender offer that I have seen related to REITs that has been completed at the highest price.  All others have been at the lowest price in the tender range.  It's amazing how many investors (6.6% of outstanding shares) were willing to bail out of this REIT at a 35% discount.

American Realty Capital Healthcare Trust (HCT) completed its tender last Friday.  HCT skipped the Dutch tender and offered to purchase up to $150 million of shares - or approximately 7.5% of HCTR's outstanding shares - at $11.00 per share.  HCT's tender was five times oversubscribed, so the REIT will purchase the tendered shares on a pro rata basis.

The tender result I am waiting for is Franklin Square Investment Corp's (FSIC) $250 million Dutch tender offer at a price of $10.35 per share to $11.00 per share. 

The Inland American tender offer was not part of a listing liquidity event like HCT and FSIC, but was a mechanism for Inland American to provide some liquidity to investors.

Mind Numbing

Here is complex bankruptcy story, as detailed by Bloomberg.  The Gherkin tower (the building shaped like a football) in London became the highest profile London property bankruptcy since Canary Wharf in 1992.  It looks like the borrower's hedging backfired, causing its liabilities to increase:

Deloitte said in an April 24 statement that the defaults stemmed from the building’s complex, multi-currency capital structure. “Adverse interest rate and currency movements have caused the total senior liabilities secured by the property to increase materially,” the firm said.

Rate swaps allow borrowers to keep payments within a fixed range even if interest rates fluctuate more widely. When rates fall, customers might pay higher costs for the swap to keep payments within the agreed range.

The building, bought for 600 million pounds in 2007, was valued at 473 million to 520 million pounds in 2012.  I can't quite figure the debt, but think it's near 550 million pounds. 

Riddle Me This

I see that Franklin Square Investment Company (FSIC) now has an investment grade rating of BBB- from S&P and Fitch's.  This follows on Corporate Capital Trust's BBB- rating from S&P.  I'm trying to understand how the two business development companies (BDCs) raise equity and borrow money to make loans to non-investment grade companies and come away as investment grade companies.    (And at year-end 2013 CCT had 16% of its investment portfolio in investments with active payment in kind elections, but this is a whole separate topic.)  I guess the sum of the parts is greater - much greater apparently - than the parts by themselves.  It's like a sausage, no one wants to know how it's made or the ingredients used, just that the end result tastes good.  I'm reminded of this scene from the Wizard of Oz whenever I think too hard about BDCs:

About Time

I have been waiting to read about investment funds moving into Spanish real estate.  Here is a Bloomberg article on a new REIT, Merlin Properties SA, being formed to buy commercial real estate in Spain and to a lesser extent Portugal. 

Do You Know What's In Your BDC?

Business development companies (BDCs) publish a list of their investments every quarter.  But do you really know what's in your BDC?  Probably not.  This article from the Financial Times is worth reading (requires free registration if not a FT subscriber).

According to the article, leveraged loans (loans to companies already with substantial debt) classified as single B, which are the main components of BDCs, made up more than a third of new issuance in 2013.  This reversed a recent trend where more higher rated bonds were issued, and this was the first time since 2004 and 2005 where more single B loans were issued than double B loans.  The resurgence of lower rated loans indicate a loosening of credit markets as investors seek higher returns in investments with higher risk.

 

The article also touches on the return of covenant-lite loans (think no-doc mortgages) and payment-in-kind loans (interest payments added to loan principal, not cash, so think negative amortizing mortgages).  I have not seen any payment-in-kind loans in BDCs, but I'm not sure whether a BDC would have to disclose whether its loan portfolio included covenant-lite loans.

 

BDCs own, originate and purchase high yield loans.  That's no secret.   Lending to small, unrated businesses is the primary mandate of the BDC structure.  The article concludes by stating that investors are attracted to B-rated loans by the chance to earn high returns will retaining seniority.  I want to see more information on the borrowers and types of loans in BDCs. 

D'Oh

At a conference earlier this week I over heard a real estate sponsor claim with pride - and a strait face -  that his REIT had no debt.  He then added the caveat that he didn't count the REIT's $40 million line of credit as debt (I'm sure his bankers have the same impression).  The sponsor also didn't include the 60%-plus debt on each of the REIT's properties.  The sponsor can make this specious boast because the REIT owns the properties through what is known as special purpose entities (SPEs), stand-alone companies (usually limited liabilities companies) whose sole purpose is to own one asset.  The catch is that the SPE's sole owner is the REIT.  So the while the sponsor's pronouncement is technically correct, it is also complete BS.

Nothing Story

This InvestmentNews story is a big fat nothing.  When I read the headline I thought ARC and KBS were in a new fight, but it turns out its an old (2009) issue.  I am shocked to learn that wholesalers would take their contact lists with them when changing jobs.  What has this world come to?

The New Bankers

Here is a great New York Times article on Blackstone's GSO debt financing unit (the same GSO that manages the Franklin Square non-traded BDCs) and its investments in Ireland.  The story is a fascinating read.  The recent financial crisis was, in my opinion, the most significant financial event since the Great Depression, and I believe we still haven't seen all its ramifications.  (And, more importantly, we have not learned the hard lessons the crisis was screaming at us.)

The rise of firms like Blackstone, which neatly stepped into the financial crisis' banking void, is real.  The article ends on an ominous note:

And the type of shadow banking that most concerns regulators — short-term borrowing involving broker dealers, hedge funds and money market funds — does not apply to Blackstone.

But, there is no doubt that its fast-growing credit business is breaking new financial ground.

“If the fund in question knows right up front what the risks are and its exposure is quasi-equity in nature that can be beneficial,” said Adair Turner, formerly Britain’s top financial regulator and co-chairman of a comprehensive study of the shadow banking industry.

“But we also know that the financial industry is forever innovating and when it does it tends to put more leverage in the system so we have to watch this very carefully.”

With firms like Blackstone, which has $265 billion to invest, the new bankers are a major force in business.

Go Global

My Bloomberg app on my iPhone does not update its industry articles as fast as Bloomberg's website.  I read this article on Blackstone's view on real estate opportunities on my iPhone last night.  The article originally appeared last Thursday.  Anyway, I guess I'm glad the app is slow because I missed the story when it was first published.

Blackstone is looking at the dislocation in emerging markets as an opportunity.  Of more interest to me is Blackstone's opinion on Europe:

While Europe’s economic crisis has eased, the shrinkage of loans and other assets that regulators are pressing banks to undertake will “be taking some oxygen” out of the region’s economies. Blackstone is forecasting “very slow growth,” (Jonathan) Gray said. (Mr. Gray is Blackstone's global head of real estate.)

For real estate investors, Gray expects forced sales by European banks to continue for several more years, fostering opportunity. Blackstone is seeking distressed warehouses, hotels and office buildings throughout the region, he said.

“When people are forced to sell, the pricing tends to be better,” he said. “In Europe, it’s not a growth story. It’s a distress story.”

Blackstone also sees "great strength" in the US housing market as construction still trails pre-recession levels.  Finally, Blackstone sees "good signs" in the US lodging market.  The "good signs" is somewhat substantiated by this Calculated Risk blog post that Las Vegas Convention traffic is 18% below pre-recession levels, telling me that one important demand component is still recovering.

Of course the global head of real estate, responsible for an $80 billion portfolio, is going to be optimistic, but it's still interesting to read where one of the largest real estate investors in the world sees opportunities.

Update

Work has intercepted blogging, but I expect more regular posts soon.   In the mean time, I've been at a loss for a pithy analysis of Kite Realty's $1.2 billion acquisition of the non-traded REIT Inland Diversified, other than it's hard to believe this deal would not have happened without American Realty Capital's and Cole's successful liquidity in several of their REITs.  Combine this with the sour aftertaste from Inland's last listing, Retail Properties of America, and any price above the $10.00 per share offer price paid by investors is a win for Inland, and for Inland Diversified shareholders who'll get fully liquidity when the merger closes.

Healthcare REITs

Here is a Bloomberg article on healthcare REITs.  The positive, but awkward article highlights two non-traded REITs, Griffin-American Healthcare REIT II and ARC Healthcare Trust.  The reporter credits, in part, Obamacare for spurring demand for medical office space as more people gain health insurance - 975,000 people signed up for insurance in December, according to the article -  and presumably are visiting doctors.  The report's main focus is medical office buildings, and excludes hospitals and senior housing, which are generally included in healthcare REITs' portfolios.

Here is a passage:

Investor interest in medical-office buildings is driving up values. Capitalization rates, a measure of returns that declines as purchase prices rise, reached a six-year low of 7.3 percent nationally in 2013, Real Capital data show. That’s still higher than the 6.4 percent average cap rate for general offices and 5.7 percent for apartments, according to the firm.

I don't understand the first sentence of the next passage, but the subsequent information on the lack of new supply makes sense:

The large pool of properties to buy gives medical office investors ample opportunities to generate more income, according to Hanson of Griffin-American. A limited amount of construction should help landlords retain tenants and keep building occupancies high, he said.

Almost 15 million square feet (1.4 million square meters) of medical offices were completed in the past two years, compared with 41 million square feet in 2008 and 2009, according to Marcus & Millichap Real Estate Investment Services. (emphasis added)

Despite the positive trends the article reports that "Bloomberg's index of 11 health-care trusts fell 11 percent, making them the worst-performing industry group in 2013. The broader REIT index slipped 1.4 percent."  I hope the reporter means that health-care was the worst REIT sector and not the worst industry in the entire market.