Registered reps who sell nontraded real estate investment trusts are about to see
a deluge of liquidity hit the market, with potentially as much as $13.6 billion in fresh equity flowing through the market due to a series of nontraded
REIT listings, mergers and special distributions.
Since April, at least a dozen such REITs have listed on exchanges, merged or agreed to merge with other REITs, announced spinoffs of parts of their real estate holdings or indicated they are teeing up for a liquidity event.
List of recent nontraded REIT liquidity events
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American Realty Capital Healthcare Trust Inc., with $1.4 billion in equity and $2 billion in assets, kicked off the 2014 nontraded REIT liquidity fest on April 7
when it listed on the Nasdaq. Last month, KBS Real Estate Investment Trust Inc. II said it
was making a one-time special distribution to shareholders of $4.50 per share, which translates into $861 million of fresh equity for investors.
(More data: Nonlisted REIT 2Q rankings)
The question facing financial advisers is how to allocate that equity for their clients. Cap rates, a valuation measure for real estate, have decreased in some areas and real estate sectors, while valuations of quality properties have increased over the past five years. Those factors create a more difficult environment for real estate investors.
According to an August report by Green Street Advisors, a type of nontraded REIT arbitrage exists: nontraded REITs that have focused on property sectors where net asset value premiums for listed REITs are very large have a chance to outperform listed REITs over their lifespan.
“In today's market, the only property sectors where public premiums to NAV are high enough to potentially offset heavy costs associated with a [nontraded REIT] are skilled-nursing facilities (NAV premium = 50%), self-storage (25%), and triple net, (30%), and even those premiums merely level the playing field” with publicly traded REITs, according to Green Street.
Other analysts keep an eye on the premium or discount to NAV of traded REITs. Traded health care REITs about a month ago had a premium of 11.5%, while traded self-storage REITs had a premium of 9%, according to SNL Financial. All traded REITs across nine sectors were trading at a discount of 1.3%, according to SNL.
There is no doubt finding the sweet spot in the market has gotten tougher for real estate managers since the 2007-08 real estate crash and subsequent recovery. According to SNL, premiums for traded REITs have fallen dramatically in the past five years. In September 2010, the traded REIT healthcare sector had a premium of 44.1% and the traded REIT self-storage sector had a premium of 31.3%.
SNL's calculation of the premium or discount to NAV is based on the consensus NAV estimates that SNL collects directly from sell-side research.
With interest rates holding at record lows for the foreseeable future, advisers should keep an eye on real estate investing, according to one economist. “In real estate, if anything, the secular drivers have improved,” said Sameer Jain, managing director and chief economist with American Realty Capital, the leading sponsor of nontraded REITs.
(Related news: SEC approves rule change for greater transparency of nontraded REITs)
“The thesis still stands if you believe, and I certainly do, that the U.S. economy, but not so much the global economy, continues to improve,” Mr. Jain said, “that's good for real estate. Replacement costs might go up, along with the ability to increase rents. And those are good drivers for real estate.”
“If you think about certain liquidity events, those great returns have happened not just because sponsors were able to buy properties at good prices, although that was certainly a contributing factor,” he said. “A major driver for returns is precisely this arbitrage between overvalued public markets and the ability to aggregate the private markets also. If there is a premium in the public markets, it bodes very well for nontraded REITs and their ability to exit and monetize those premiums."
