Wells Real Estate Funds Inc., one of the most prominent sponsors of nontraded real estate investment trusts, is taking a pass on charging clients a heavily criticized fee tied to changes in a REIT's management.
REIT sponsors over the past 10 years consistently have imposed the charge — commonly referred to as an internalization fee — when the contract between the REIT and its outside adviser expires, with the REIT then acquiring the outside adviser. That charge, which has drawn criticism because it typically isn't fully disclosed in offering documents, has cost investors in several prominent REITs hundreds of millions of dollars.
The REIT becomes self-managed by buying the external adviser, in effect internalizing the property management or acquisition functions.
Wells REIT II's decision to forgo the internalization fee was first reported by a website, rationalrealist.blogspot.com.
Executives with Wells Real Estate Funds didn't return phone calls seeking comment last week, and a company spokesman, Rick Matthews, wrote in an e-mail that the company wouldn't make a Wells executive available for an interview.
“There are downward pressures on these fees and on fees generally in the financial services industry,” said Kevin Hogan, chief executive of the Investment Program Association, a trade group for the direct-investment industry.
Such changes indicate greater alignment by nontraded REITs with investors' interests, he said.
Inland Western REIT, now Retail Properties of America Inc., in 2007 bought its adviser for $375 million in stock. After lawsuits from investors, the REIT returned shares that lowered the purchase price of its adviser to $285 million.
Another nontraded REIT, Wells Real Estate Investment Trust Inc., in 2007 paid about $175 million in stock to acquire the outstanding shares of its adviser.
WELLS TO ACQUIRE ADVISER
That practice has changed at Wells Real Estate Funds, which manages $11 billion in assets and is known for the outspoken and charismatic leadership of chief executive Leo Wells.
Last month, the $6.2 billion Wells REIT II said in a Securities and Exchange Commission filing that it will have an “assignment option” to acquire its adviser, Wells Real Estate Advisory Services II Inc., next year.
“No payment is associated with the assignment” to acquire the adviser, the filing said.
Multimillion-dollar internalization fees have raised questions about the $84 billion nontraded-REIT industry, and some major sponsors, including American Realty Capital, have eliminated those fees. The issue compounds a relationship with securities regulators already made unfriendly because of concerns about valuations and disclosures to investors.
The fact that Wells Real Estate Funds won't charge the fee signals a shift in the industry, some executives said.
“This is certainly positive for investors, and Wells was forced to go this route because of competitive pressure,” said Daniel Wildermuth, chief executive of Kalos Capital Inc., an independent broker-dealer that specializes in alternative investments.
“It's become standard,” he said. “If Wells had done anything else, they would have opened themselves up to a lot of criticism.”
“It's very logical for this product to evolve,” said Nicholas Schorsch, chairman and chief executive of American Realty Capital, which offers a number of nontraded REITs. He said that his firm doesn't have an internalization fee for its nontraded REITs.
“This [fee] made no economic sense to investors. There's no logical reason they would pay,” Mr. Schorsch said.
“Increasingly, investors are focusing on pay for performance,” he said, adding that such a change would be significant in the industry.
“Fees are being deferred, and it's almost like a performance fee,” Mr. Hogan said.
Another development is that fees are being capped and may be subject to investor approval, he said.
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