On Advice

Nontraded-REIT party is about to commence

May 5, 2013 @ 12:01 am

By Bruce Kelly

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Investment advisers and their clients will reap a bonanza over the next two years or so as a number of large nontraded real estate investment trusts go public or are acquired.

The windfall, however, presents a dilemma for advisers.

Should they sell out? Double down? Hold steady?

The good times will kick off this month when Chambers Street Properties, which has nearly $1.7 billion in shareholder equity, lists May 21 on the New York Stock Exchange.

Cole next up

Next month, Cole Credit Property Trust III, which recently fended off a hostile-takeover bid from rival American Realty Capital Properties Inc., also plans to begin trading on the Big Board.

Investors in Cole's sister real estate investment trust, Cole Credit Property Trust II, will join the REIT conga line sometime before the end of September, when that illiquid REIT plans to merge with a publicly traded one. Cole II and Cole III are hefty, with stockholder equity of $1.4 billion and $3.7 billion, respectively.

Chambers Street and the Cole REITs are far from alone. Other large REITs have indicated that they soon will proceed with listings or mergers.

Those include American Realty Capital Healthcare Trust Inc., Columbia Property Trust Inc. and Griffin-American Healthcare REIT II.

For these REITs in total, that is potentially $11.2 billion in equity from nontraded REITs that will be unlocked for investors and their advisers. The REITs combined have $21.2 billion in assets.

The Federal Reserve is only adding fuel to the nontraded-REIT party — and the market, broadly — by pumping money into the system.

Of course, there is no guarantee that all the potential “liquidity events,” as they are dubbed by the REIT industry, will go off without a hitch. Mergers could fizzle and listings could be blindsided by bad news.

Nontraded REITs typically are sold at $10 a share, and it is anyone's guess whether investors will see that returned in these deals, though the market recently has regarded such deals favorably.

Indeed, REITs in general have enjoyed a terrific run since the depths of the credit crisis in 2009.

Keeping that in mind, the spate of liquidity events is still terrific news for the $10 billion-per-year nontraded-REIT industry, particularly as it has been stung in recent years by a number of high-profile REITs that have seen valuations slashed and fee structures heavily criticized.

The FTSE Nareit All REIT Index, which comprises traded REITs, beat the S&P 500 in terms of annual percentage change for each year from 2009 to 2012. Through the end of trading last Monday, the FTSE Nareit All REIT index was also ahead of the S&P 500, with the REIT index posting a total return of 14.3%, versus 12.5% for stocks.

Clients bought these nontraded REITs looking for steady yield and income, so what are financial advisers to do with all this bounty?

Do they hold on to the REIT in its new form and continue to collect the dividend or do they reallocate into another income-producing alternative investment such as a traded or nontraded business development company? Or do they simply double down on another nontraded REIT and close their eyes, hoping that the disasters of large REITs that raised money before the credit crisis and lost billions in value are nightmares of the past?

No easy answer

Every client is different, and there is no easy, one-size-fits-all answer, advisers and consultants said.

One brokerage executive, whose firm specializes in alternative investments, said that advisers should consider a little bit of each of the three options.

“For a typical client, once the REIT lists and begins trading, we'll sit on it a little bit,” said Daniel Wildermuth, chief executive of Kalos Capital Inc.

Recent nontraded-REIT initial public offerings have dropped somewhat at first and then rebounded, he said.

“Then we generally liquidate [the position] and reallocate cash across the portfolio. What has changed since clients bought these nontraded REITs is that there are simply more options,” Mr. Wildermuth said.

“Advisers are not just plowing back money back into real estate,” he said.

Other alternative investments such as nontraded BDCs and oil and gas partnerships also are attractive, Mr. Wildermuth said.

“They have strong performance expectations and low correlations to other asset classes,” he said.

Some advisers may decide to double down on nontraded REITs, Mr. Wildermuth said.

That may work for a “small percentage” of a client's portfolio but would be a “simplistic” strategy for an adviser to use in general, he said.

Mr. Wildermuth and others, however, aren't ready to dismiss real estate as an asset class, particularly as the Federal Reserve maintains an easy monetary policy.

“The fundamentals are so favorable for real estate. Valuations in real estate are up but still below their historical average,” Mr. Wildermuth said.

“Real estate is undervalued,” he said. “And it's the more unique because the Fed is throwing fuel on the fire by making money so cheap.”

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