Indies shy away from new offerings

The marketplace for nontraded real estate investment trusts has exploded with new offerings over the past couple of years, but executives at independent broker-dealers are leery of opening their platforms to such products.

New nontraded REITs could struggle despite this being a favorable time to buy real estate, executives said. Prices on commercial real estate assets are depressed, and many investors are still afraid of the market.

Regardless of the difficulties facing new offerings, last year was a record year for the nontraded-REIT industry, according to Blue Vault Partners LLC, a research firm that focuses on that market. Fifteen such REITs were introduced in 2010, compared with 12 the previous year.

Brokerage executives are not welcoming the new products with open arms.

“We’re not taking on any new product, although we’re looking at some,” said Russell Diachok, chief executive of Geneos Wealth Management Inc. “I think a lot of smaller players came out of the woodwork” since the real estate market collapsed in 2007, he said.

“It’s not surprising that there are so many offers out there,” said Don DeWaay, chief executive of DeWaay Capital Management. “Properties are deeply discounted. I believe it’s a good time to do real estate.”

“With so many offerings, the main concern for any broker-dealers is: Can the fund raise adequate money to get adequate diversification in its portfolio?” Mr. DeWaay asked.

‘MORE CAUTIOUS’

“Broker-dealers are taking a much more cautious approach to a fund’s theme, team and track record,” said Nicholas Schorsch, CEO of American Realty Capital, which is the sponsor of five nontraded REITs. “A lot of products have not gained traction, and two or three have shut down,” he said.

Such sentiment will make it very difficult for some new nontraded REITs to raise enough capital to become viable and buy the commercial real estate assets required to generate dividends for clients, according to brokerage and real estate executives. In those cases, investors should expect their money to be returned.

Nontraded REITs are peculiar in that they are sold only by representatives affiliated with independent-contractor broker-dealers.

Executives at such firms say that wirehouses won’t sell the product because of conflicts it would create with the investment banking side of the house. The banks attached to wirehouses underwrite public offerings and secondary offerings, and also trade those products. Therefore, they would be loath to put a nontraded REIT on their platform.

Also, nontraded REITs generally have a high commission — about 7% — while only a very thin secondary market allows investors to sell shares. The endgame for investors is to cash out after a nontraded REIT becomes publicly traded or is liquidated.

“Broker-dealers are much more keenly aware of regulation and continuing due diligence,” Mr. Schorsch said. “I think it’s a very positive trend for the industry.”

Indeed, securities regulators have made it clear that they are carefully looking at the sale of private investments, including nontraded REITs.

Last year, Richard Ketchum, chairman and chief executive of the Financial Industry Regulatory Authority Inc., said that examiners of broker-dealers are paying close attention to sales of the products.

In 2009, the market for nontraded REITs — which invest largely in commercial real estate — soured. Many of the biggest ones slashed dividends to investors and shut down redemption programs.

That didn’t stop new products from coming to the market.

NEWCOMERS LAG

Between 1990 and 2005, 34 nontraded REITs were in the market, according to Blue Vault Partners, a firm that analyzes nontraded-REITs. At the end of last year alone, 43 such funds were raising capital from investors, while 18 had closed to new investment. The industry raised $8.5 billion in new capital last year, compared with $6.5 billion in 2009.

But the newcomers, for the most part, did not get their hands on that capital. The 10 biggest nontraded REITs raised 82.5% of the capital, according to Blue Vault.

Still, executives are bullish on the industry’s long-term potential, particularly if the products gain popularity among investment advisers who charge fees rather than a broker’s commission. Three nontraded REIT funds for fee-based advisers could be launched soon, executives said.

E-mail Bruce Kelly at [email protected].