Nicholas Schorsch's nontraded real estate investment
trust empire is in disarray. Now, some of the hotels in an ARC
REIT he controls are also in disrepair.
The hotels in question are owned by American Realty Capital Hospitality Trust Inc., which bought the properties as part of its February purchase of the Equity Inns Lodging Portfolio for $1.8 billion from a fund sponsored by
Goldman Sachs.
“The most recent property inspection reports revealed potentially harmful life safety issues” at five hotels owned by the nontraded
REIT, according to a report this month from Trepp, an information and analytics firm that focuses on commercial mortgage-backed securities, commercial real estate and banking. The hotels include Homewood Suites in Peabody, Mass., and two Hampton Inns, one in Glen Burnie, Md. and another Overland Park, Kansas. The chain has 96 hotels.
The safety and deferred maintenance issues include uneven, raised or cracked sidewalks, a sunken storm drain in the driveway; and a room with ants.
ARC Hospitality claimed that the Trepp data was historical and the property issues cited relate to the portfolio of 106 properties prior to the purchase of 96 of those properties by ARC Hospitality in February 2015. The
REIT said that Key Bank, the servicer for the Equity Inns lodging portfolio loan, has confirmed that there are no current issues with any of the 96 Equity Inns properties.
Trepp said it could not immediately determine when the property inspections on which its report was based were conducted.
ARC Hospitality was created by AR Capital, a company founded by Mr. Schorch. He and his partner, Bill Kahane, control the adviser to the
REIT, American Realty Capital Hospitality Advisors, according to ARC Hospitality's 2015 proxy statement. The adviser is responsible for day-to-day management of the
REIT.
Mr. Schorsch was also the former chairman and CEO of American Realty Capital Properties, known by its former ticker symbol ARCP. He resigned in December, two months after the company disclosed a $23 million accounting error over the first half of 2014 that was intentionally not corrected.
The accounting error sent Mr. Schorsch's nontraded
REIT empire into a tailspin. Sales of ARC nontraded REITs have stalled. And this month, Mr. Schorsch and his partners sold 60% of his private real estate company to
Apollo Global Management for $378 million in cash and Apollo stock.
A website, Commercial Observer,
first reported the safety issues at the hotels.
In a press release from February, Mr. Mehlman
said the purchase of the Equity Inns hotel portfolio was the largest acquisition in the history of the nontraded REIT industry.
One industry observer noted that the problems at the ARC Hospitality REIT were indicative of general shortcomings in due diligence at nontraded REITs.
“Why and how are nontraded REITs incentivized,” asked Brad Thomas, editor of Forbes Real Estate Investor. Management at such REITs “gets paid for building assets under management, not to manage the risk of these properties. Typically, such REITs are just trying to grow these properties and don't focus on the granular pieces of the operation.
“In general, nontraded REITs raise equity and then deploy it at such a fast rate that they don't conduct the necessary due diligence that is in an investors' best interests,” he said. “There is so much pressure to deploy that equity that [managers] don't conduct proper due diligence. That's why publicly traded REITs have much better risk management practices and are more judicious in sourcing of deals. Also, nontraded REITs can hire third-party companies to perform due diligence while listed REITs spend more time on the ground looking at properties.”
Mr. Mehlman said ARC Hospitality “performed thorough and extensive due diligence on the Equity Inns lodging portfolio as it does with all acquisitions. The capital expenditure requirements to date have been anticipated and include normal course of business items.”
An earlier version of this story incorrectly reported that eight hotels owned by ARC Hospitality had maintenance and safety issues, and identified two Residence Inns, one in Tinton Falls, N.J. and another in Tuscon, Ariz., as among those with problems.
