Last week's initial public offering by Retail Properties of America Inc. Ticker:(RPAI), the nation's third-largest shopping center REIT, produced some punishing results for investors in the heretofore nontraded real estate investment trust and could dampen the enthusiasm for future REIT stock offerings.
Despite an improving climate for IPOs, Retail Properties' $8 offering price not only came up well short of its expected pre-offering price of $10 to $12, but it took some reverse-stock-split engineering just to get the price to $8.
For those investors who originally bought the REIT at $10 a share nearly a decade ago, the actual split-adjusted value of the stock is less than $3 per share.
“It's got to be a bit of a disappointment, because I'm sure Retail Properties had hoped to take advantage of the recent bull market in stocks,” said Orest Mandzy, managing editor at Commercial Real Estate Direct, which tracks the REIT markets.
Mr. Mandzy said the IPO's pricing could be bad news for other nontraded REITs that had been considering going public.
“If a stock comes out substantially lower than the expected price, it would naturally stifle other prospective IPOs,” he said. “We've seen that happen in the mortgage REIT sector. We had been tracking 10 mortgage REITs that filed IPOs in the middle of 2009. [Starwood Property Trust Inc. (STWD)] made a killing, raising more than expected. Then the market turned south. Three others managed to price, but the remaining six never went public.”
HELP FROM THE MARKETSAs with any nontraded REIT, an IPO is a welcome event, but it appears that longtime investors in Retail Properties will need some help from the public markets to get a positive return on their original investment.
Retail Properties, which changed its name from Inland Western Real Estate Trust prior to the IPO, saw its shares jump 75 cents, or 9%, shortly after trading began Thursday morning. But based on the complex formula of reverse stock splits used in the IPO, it will take an incredible rally for original investors to get back to even. The stock closed the day — and the week since the market was closed for Good Friday — at $8.76.
REVERSE STOCK SPLITBy Mr. Mandzy's estimates, investors who originally bought in at $10 per share when the nontraded REIT was raising more than $4.8 billion from 2003 to 2005 now are holding stock worth about $2.90 on a split-adjusted basis.
According to FactRight LLC, a company that analyzes alternative investment strategies for financial professionals, the Retail Properties IPO engineered a 10-for-1 reverse stock split in addition to a recapitalization of existing common stock that amounted to a 2.5-for-1 reverse stock split.
The company also opted to offer only a quarter of the shares during the initial offering, with three follow-up stock sales scheduled over the next 18 months.
“We don't know why they split the shares that way, and I don't want to speculate,” said FactRight president and chief executive Anthony Chereso.
Representatives from Retail Properties, which operates shopping centers in 35 states and includes among its tenant roster Best Buy (BBY), Wal-Mart (WMT) and T.J. Maxx (TJX), did not respond to a request for comment after the IPO.
But in a letter to shareholders Thursday, company president and chief executive Steven Grimes referenced the impact of the economic recession on the real estate market.
“It is uncertain if and when we will see a full recovery,” he stated. “We have a demonstrated leasing-and-property management platform, an experienced management team with a proven track record of successfully navigating through turbulent times, and a capital structure that we believe is well-positioned for growth.”
Even at the middle range of the pre-IPO target price of $11, investors in the nontraded REIT were expected to be holding public stock valued at well below their original investment.
Most analysts estimated a split-adjusted value of between $4 and $4.80 per share if the company went public at $11.
Even after including the total dividend distributions of nearly $4 per share, accumulated over the full length of the investment period, investors were “only getting 80 cents back on every dollar they invested,” said Michael Stubben, president of MTS Research Advisors.
"NO SCREAMING SUCCESS'As tragic as the Retail Properties story might appear immediately following the IPO, the problems with this particular investment actually have been unfolding since shortly after the fund stopped taking in capital in 2005.
“This certainly wasn't a screaming success, but you have to consider what was going on in the market,” said Mr. Chereso, who compared the giant REIT that was building a portfolio of properties leading into the financial crisis to an individual buying a big house at that same time.
“Inland was not unique to the situation of raising capital prior to 2008 when pricing was high and financing was costly,” he added. “But when the market crashed, they found that prices of the properties in the portfolio were overvalued, and from there, the portfolio wound up with all kinds of legacy issues and debt maturity issues.”
Investors, meanwhile — as with any notoriously illiquid nontraded REIT — had little choice but to ride it out, even as dividend yields were being cut from 6.4% down to 1% by 2010. The dividend has since been increased to 2.5%.
Critics of nontraded REITs often cite the lack of transparency with regard to market valuations, and Inland's September 2011 filing with the Securities and Exchange Commission might lend some credence to that argument.
TIMING OFFIn the September filing, Inland valued its shares at $6.95, which is 30.5% below the original $10 price but 140% above the split-adjusted value of Thursday's IPO.
Some analysis on how this particular REIT might have been more successful includes the comparison to companies such as American Realty Capital Trust Inc. (ARCT), which went public in March after only about four years of operating as a nontraded REIT.
But American Capital, which listed at $10 and is now trading close to $11, was launched as a nontraded REIT in 2008 when properties were just starting to get cheap and it made sense to keep the debt on the longer-term end.
Another example of a contrast with Retail Properties involves another Inland nontraded REIT.
The Inland Retail Real Estate Trust was purchased in early 2007 for $14 a share by DDR Corp. (DDR), a public REIT.
“That was a home run because it was perfect timing,” Mr. Stubben said of the sale. “It might have been another home run if they had tried to sell or list [Retail Properties] back then.”