End Game

End Game

Non-traded REITs face difficult decisions for liquidity events.

Although non-traded REITs obtain the vast majority of returns from dividends, an investor’s total return depends on the success of the liquidity event – an event that allows investors to cash out of their investments. (Remember, non-traded REITs are illiquid – there is no real secondary market for non-traded REIT shares.)

“Generally, the prospectuses of non-traded REITs have not specified a particular exit strategy in advance, providing the flexibility for management to choose the best option for shareholders when the time comes,” says Chuck Schreiber, CEO of KBS Capital Advisors, a sponsor of non-traded REITs.

A successful liquidity event is highly dependent on timing and the strategy a non-traded REIT pursues. Since those decisions are made by the company’s board and executive management, their expertise and track record is extremely important, says Keith Allaire, a managing director with Robert A. Stanger & Co., a Shrewsbury, N.J.-based investment banking firm that focuses on real estate.

“The boards know investors expect liquidity, and there is recognition of pressure to find a liquidity event, but not act to the detriment of the investors,” Allaire says. “They must watch for an opportune time for a liquidity event, as well as determine the best strategic alternative.”

No Obvious Choice

What exactly is a non-traded REIT liquidity event, and how do non-traded REIT sponsors decide what to do and when to do it? The answer is far more complicated than you might expect, and often gives rise to second guessing and criticisms.

Liquidity events include:

·      liquidation through an outright portfolio sale to a third party

·      listing on a public exchange

·      merger with an existing public company

“It’s hard to say which investment strategy is best because there are not enough data points to say one did better or worse,” says David Steinwedell, a managing partner with Blue Vault Partners, an Austin, Texas-based research firm that specializes in non-traded REITs. The firm recently conducted a study in conjunction with the Real Estate Finance and Investment Center at The University of Texas at Austin McCombs School of Business.

The research analyzed 17 non-traded REITs that have experienced “full cycle” liquidity events and found that as a group, they offered “respectable” total returns with an average internal rate of return of 10.3 percent. (Another five non-traded REITs are in the midst of executing liquidity events).

The first non-traded REIT full-cycle liquidity event took place in 1997 when Cornerstone Realty Income Trust listed its shares on a national stock exchange. Of the 17 non-traded REITs that have gone full-cycle, five were acquired by a third-party, five listed on an exchange and seven merged with other companies.

Most non-traded REITs have a 10-year life span, but the end date for the REIT can be modified by an investor vote. Typically, boards start investigating their options for liquidity events around year five. “They want to take their time and not be rushed to list or liquidate,” Steinwedell explains.

Mr. Market’s Influence 

Deciding on a liquidity event strategy is complicated enough without the volatility and uncertainty surrounding the economy, the credit/debt markets and the love-hate relationship investors have with recent IPOs, according to Kevin Hogan, president and CEO of Investment Program Association, the national association that represents non-traded REITs and other direct real estate investments.

“You only have to look at far as the Facebook IPO to see the instability in the IPO market,” Hogan contends. “The environment today is hard to pin down, and there are so many influencing factors that boards today have a really difficult time making the decision.”

Non-traded REITs face an extra layer of complexity because of the cyclical nature of commercial real estate, Allaire says. Boards not only have to consider current commercial property values (selling the portfolio when property values are higher rather than lower), but also the fundamental performance of their own portfolios.

“Market conditions have the overwhelming impact on liquidity events,” Allaire notes. “For example, in this economic environment, a non-traded REIT might have underperforming assets because of the recession – the fundamentals might be suffering – lower occupancy and lower rental rates. As a board member, you’re going to say that now is not the time to harvest the value of the portfolio.”

In 2007, for example, at the height of the commercial property boom, four non-traded REITs completed full-cycle events in 2007, the most in any one year, according to Blue Vault Partners.  

Beyond commercial property valuations and market fundamentals, non-traded REIT boards must take into consideration the availability of capital, Allaire says. “Obviously, the availability of capital determines whether you can sell the portfolio – buyers have to be able to finance transactions,” he explains.

More Liquidity Events

Many of the non-traded REITs that were launched in the mid-2000s are reaching the five- and six-year mark where boards are announcing their intentions to pursue liquidity events. “They’re looking at both listing and liquidating,” Steinwedell says. “In the past, they would have gone directly into the public market with an IPO, but now more than any time in the past, they’re looking at both options.”

A handful on non-traded REITs have begun trading on public exchanges this year – American Realty Capital, Healthcare Trust of America and Inland Western Retail Real Estate Trust, which listed as Retail Properties of America.

“We’ve already have more listings this year than in previous years, but it’s still not a tremendous amount because people are really trying to get a sense of when and where the market will settle,” Steinwedell says. “If you look at the non-traded REITs that converted to listed REITs in 2010 and 2011 – those have not done that well, and that led to a number of non-traded REITs deciding not to list.”

However, Steinwedell is quick to note that non-traded REITs aren’t waiting as long to execute liquidity events. “I expect that there will be quite a few liquidity events over the next 12 to 18 months,” he predicts.

Non-traded REITs are increasingly under pressure from investors to turn over the investments more quickly, Steinwedell explains. But that doesn’t mean that boards are simply bowing to investor pressure. “Some of the activity is driven by the improving market,” he says.  

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