Non-traded REITs that have been watching capital flee the sector are expecting to see the tide turn with more investors returning in 2018.
Investment banking firm Robert A. Stanger & Co. is predicting that fundraising for non-traded REITs will reach $4.2 billion this year, which is down from the $4.5 billion the sector raised in 2016 and the lowest level in more than 15 years. There are numerous factors that have contributed to the sharp decline that is well below the peak of $20 billion raised in 2013.
The sector has struggled to move away from historically high fees and adapt to new regulatory rules that have created more transparency on account statements. A new Department of Labor (DOL) Rule also raised questions on whether financial advisors could sell non-traded REITs into tax-exempt accounts, which represent about 40 percent of sales in the sector.
“That uncertainty clouded the picture and caused some firms and reps to pull back on non-traded REIT sales,” says Kevin Gannon, president and managing director at Robert A. Stanger & Co., which is based in Shrewsbury, N.J. On top of that, the level of liquidity events has fallen off dramatically and the booming stock market has pulled more capital away from alternatives such as non-traded REITs, he adds. However, many anticipate brighter days ahead with fundraising that is forecast to rise to $5.4 billion in 2018; $7.2 billion in 2019 and $8.6 billion in 2020, according to Robert A. Stanger. Fundraising is expected to gain traction as the confusion surrounding the DOL Rule has settled. The entrance of Blackstone to the non-traded REIT sector in January has brought more attention and expanded distribution capabilities that could give the entire industry a boost.
Sales channels expand
Traditionally, the non-traded REIT sector has relied heavily on broker-dealers and registered investment advisors for fundraising. Five years ago, JLL Property Income Trust launched with the first selling agreement with a wirehouse for a non-listed REIT. The recent arrival of Blackstone opened that wirehouse channel much wider to now include the likes of Merrill Lynch, Morgan Stanley and UBS, among others.
“Now we see these large brokerage firms putting other products on their platform, and we expect more,” says Gannon. Currently, there is about $65 billion to $70 billion in total capital invested in non-traded REITs and Robert A. Stanger is forecasting that it will double to $130 billion to $150 billion over the next several years as a result of Wall Street firms using non-traded REITs to provide non-correlated access to real estate investment opportunities.
Two sponsors, KBS and RW Holdings (formerly Rich Uncles), have also introduced online fundraising platforms similar to the crowdfunding model that allows them to raise capital directly from investors without going through brokers or other financial intermediaries. “In my opinion, direct investment overall is increasing, through online capital portals and robo advisors. So I expect the non-traded REIT industry also will start to capture those dollars when they start to adopt more direct channels to their end user,” says Jordan Fishfeld, managing director with CFX Markets. CFX Markets is a secondary markets platform for non-exchange traded securities, including non-traded REITs.
Another factor that will help attract more capital to the space is that the quality of sponsors is increasing along with a growing field of institutional players, adds Fishfeld. In addition to names such as Blackstone, JLL and Cantor Fitzgerald, Starwood is expected to start actively fundraising for its new non-traded REIT in early 2018. VEREIT also announced recently that it would sell its non-traded REIT sponsor Cole Capital to an affiliate of the CIM Group.
Educating investors on market shifts
Although the tide is turning for fundraising, it still has a long road ahead to regain previous high levels. “Some people might look at those projections and say, ‘Oh, my gosh. It’s going to take four years to get back to where you were five years ago—why is that going to take so long?’” says Allan Swaringen, president and CEO of JLL Income Property Trust.
That slow rebound is in part a reflection of some of the changes occurring within the non-traded REIT industry that include the exit of some legacy sponsors, along with the addition of new institutional players and new products, as well as a broader secular shift in the value proposition for core real estate. All of those factors have involved educating investors on the new products and new performance expectations.
Over the past decade, sponsors were focused almost exclusively on the independent broker-dealer channels. The value proposition was to raise as much capital as possible, invest it in a single property type and then list those vehicles on the stock market as the exit strategy. The underlying premise behind that strategy was based on declining interest rates and declining cap rates, notes Swaringen.
However, most investors recognize a market shift, where continued cap rate compression will be difficult to achieve. As a result, non-traded REIT products are being sold more for income, durability and modest appreciation versus the ability to hit a “grand slam” and deliver returns upwards of 20 percent, says Swaringen. “I do think you will see increasing capital flows, but I do think it is a different value proposition today,” he adds.