The illiquid nature of private real estate investments is one of the biggest challenges for both sponsors and investors. One firm that's hoping to change that is Realto Inc., which has built a web-based marketplace aimed at providing a method for secondary trading of illiquid real estate and alternative securities.
The Overland Park, Kan.-based company is attempting to improve the difficult and time-consuming process of trading in-and-out of private real estate, making it easier and more lucrative for broker-dealers, wealth managers and investors. Currently, the platform allows investors in non-listed REITs to have a secondary liquidity event, and it will soon accept investors in any type of fund structure.
“For so long, the secondary liquidity marketplace has been unregulated and unfair, with vulture funds trying to take advantage of frustrated investors by making deeply discounted mini-tender offers—25 percent to 30 percent less than they’re worth,” says Don Hancock, CEO of Moloney Securities, a St. Louis-based broker-dealer that leverages Realto’s platform to sell shares of non-traded REITs. “But now investors can set their own price and find a buyer in an open marketplace. It’s disruptive technology that we’ve been waiting for.”
Billions in pent-up demand
Whether an investment vehicle is structured as a non-listed REIT, a fund or a single-asset LLC, sponsors struggle to soothe investor concerns regarding lack of liquidity, and this often ends up dissuading investors from what can be lucrative investment opportunities. In the past, daily liquidity opportunities and transparency did not exist in the secondary trading of real estate and other illiquid securities.
“The biggest fundraising hurdle and biggest frustration for investors is the uncertainty of the hold period and/or exit strategy,” says Realto’s CEO and Co-Founder Brian King. “Many of these non-listed REITs are seven to 10 years old and nowhere close to an exit.”
Historically, investors who didn’t want to (or couldn’t) wait for a liquidity event such as an IPO or portfolio sale had only two options: redeeming their shares/investment through the issuer or off-loading their interests through a mini-tender (tender offers for less than five percent of a company’s stock). Neither option is ideal.
Because most non-traded REITs have annual redemption limits, investors usually end up on a waiting list. Non-traded REITs have billions of dollars in their redemption queues, and that doesn’t even include investors looking to sell their interest in private funds or LLCs.
“We’re aware of one sponsor with $130 million of investor requests in its redemption queue and no way to fill them,” King notes.
While there’s nothing inherently wrong with mini tenders, many investment firms make a practice of preying on retail investors who are aren’t aware that they have another option now. The problem is so prevalent that the SEC provides specific guidance to investors on their website, warning them that these offers catch investors off guard.
“Many investors who hear about mini-tender offers surrender their securities without investigating the offer, assuming that the price offered includes the premium usually present in larger, traditional tender offers,” according to the SEC website. “But they later learn that they cannot withdraw from the offer and may end up selling their securities at below-market prices.”
According to King, “Investors aren’t looking for a secondary market for these assets because it hasn’t existed. When you’re creating something that hasn’t existed before, the number one hurdle you have is creating the awareness and letting people know that there are other alternatives.”
Building relationships with broker-dealers
Unlike crowdfunding companies, Realto focuses on secondary transactions vs. primary transactions. “We’re not necessarily helping somebody raise money for any particular building or fund, but a sponsor could use our platform to allow secondary transactions in that fund,” King says. “There’s literally trillions of dollars of opportunity for that.”
Realto received broker-dealer approval from the Financial Industry Regulatory Authority last November, allowing it to go live with its first trade: Class B restricted shares of Phillips Edison & Co. The Cincinnati-based company, one of the largest owners and managers of grocery-anchored centers, completed a $478 million IPO in July 2021.
Earlier this year, Realto’s platform earned Alternative Trading System (ATS) designation from the SEC. As an ATS, the company can now allow additional order requests and two-sided quotes.
After successfully closing its latest venture round in May—$4.5 million led by Firebrand Ventures with investments from KCRise Fund and other key contributors—Realto plans to open its platform to private real estate investments. The company is taking a traditional approach rather than tokenizing it or utilizing blockchain, according to King.
The influx of funds will allow Realto to expand its team of software engineers. “Technology is the lifeblood of the Realto platform, and we are focused on expanding this team,” King says.
The firm is also looking to add headcount to operations, legal, compliance and sales. Its sales team is responsible for building relationships with broker-dealers and real estate sponsors to create a constant flow of supply on the sell side.
Many broker-dealers that have bought shares of non-listed REITs need a way to shift these investments off their books, says Moloney Securities’ Hancock. And it’s not uncommon for brokers-deals to be stuck with hundreds, if not thousands, of orphaned accounts that a secondary liquidity event would solve.
“Our desire is to work with broker-dealers—we’re not trying to take business away from them,” King says, adding that the firm created a tool called Advisor View specifically so brokers and broker-dealer firms would have visibility and transparency into their transactions.
Given the pent-up demand on the sell side, as well as the buy side, it’s reasonable to wonder why no one has tackled the issue of providing secondary trading of illiquid real estate and alternative securities before now.
“I think it’s just been too tedious for somebody to try to accomplish,” says King. “But when you can leverage technology, it’s very, very scalable.”
Previously, the exchange of securities has been very paper-dependent and usually required medallion stamps, which guarantee that an authorized signature to transfer securities is authentic. The entire process was cumbersome and lengthy; investors had to wait 10 to 12 weeks to get their money.
Through technology, Realto has been able to steer around these roadblocks. Its platform is fully electronic, allowing both buyers and sellers to set up accounts online and use e-signatures to transact. The company was able to establish its own automated, centralized clearing mechanism that executes and settles trades in three days.
By leveraging technology, Realto has also been able to reduce the transaction fees that sellers have traditionally incurred. The firm charges a 2.9 percent transaction fee to the seller, significantly less than the 6.0 to 12 percent that buyers and sellers are used to.
Realto has developed software integrations (APIs) that connect and interface with several broker-dealer organizations. Moreover, it has already established relationships with the two primary transfer agents in the industry and will roll out APIs with them so real estate investors can simply click a button within the transfer agents’ platforms to sell.
“It’s something that we couldn’t offer to our clients before, so it’s a win for us,” Hancock says.