Nontraded REIT Cole in sweetheart deal with sponsor, manager

Merger latest in industry roundly criticized for not giving investors a return

Mar 6, 2013 @ 3:41 pm

By Bruce Kelly

One of the giant nontraded real estate investment trusts, Cole Credit Property Trust III, plans to buy its asset manager and sponsor company, Cole Holdings Corp., and will make an upfront payment to management and its founder, Chris Cole, of $127 million in cash and stock for the transaction.

According to investment bank Robert A. Stanger & Co. Inc., the REIT, known in the industry as Cole III, is the second-largest in terms of its market cap, with close to $4.8 billion in equity raised from investors since it was launched in 2009.

Using leverage, the REIT has $7.4 billion in real estate assets.

The transaction is scheduled to close in April, and the new company, Cole Real Estate Investments Inc., is expected to be listed in June on the New York Stock Exchange and will continue to be a REIT.

Cole III, which currently has a valuation of $10 per share, now pays investors an annual dividend of 65 cents per share. That will rise to 70 cents per share after the transaction.

The Cole III merger is one of a recent spate of nontraded REITs that have announced mergers or listings in an industry that recently has been roundly criticized for not giving investors a return or way out of the investments.

Cole Holdings is a capital-raising monster, so the REIT is acquiring a formidable presence in the independent-broker-dealer industry, which is the main channel for selling nontraded REITs. According to a presentation to investors, Cole raised $1.28 billion in assets in 2012, or roughly $100 million per month, putting it among the top in the industry.

“Fees from direct real estate investment are derived from new capital deployment, like a property acquisition fee, or from ongoing management, like a typical advisory fee,” said Jeff Holland, head of capital markets at Cole Real Estate Investments.

“The vast majority of fees earned in the non-listed REIT sector are those generated when new capital is deployed into real estate assets while the ongoing fees are considerably less impactful,” he said. “New capital equates to higher fee generation.”

As part of the transaction, Mr. Cole and management also will receive $20 million in stock once the NYSE listing is accomplished. They may also receive an earn-out in 2017 based on the company's performance, as well as another contingent listing fee six months after the listing, based on its market value in the month following that period.

Upfront stock considerations for management are subject to a three-year “lockup” period.

The Cole III deal marks the second time this year that a nontraded Cole REIT has begun the process of listing its shares. In January, Cole Credit Property Trust II, which has $3.7 billion in real estate assets, said it intended to merge with Spirit Realty Capital, a listed REIT with $3.4 billion in assets.

Large upfront payments to management for nontraded-REIT transactions have drawn criticism from investors in the past. Some REITs recently have waived such fees, which are commonly known as “internalization fees.”

“This is not a pure internalization, because the REIT will get future income from future nontraded REITs,” said Keith Hall, managing partners of KBS Capital Advisors, a large real estate investment company.

“I like this model, out of all the models out there,” he said, noting that another REIT sponsor, W.P. Carey Inc., makes acquisitions in a similar manner by building up a REIT and then selling it to themselves.

“We've been kicking it around here,” Mr. Hall said. “The question is, will the market be receptive to it?”


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