Most post-IPO/merger nontraded REITs lag: Study

70% trailed benchmarks, only five of 17 outperformed; fees weigh heavily

Jun 7, 2012 @ 12:28 pm

By Bruce Kelly

After a sale of assets, a merger or an IPO, individual nontraded REITs over the past two decades have consistently underperformed the broad market of real estate investing, according to a new study obtained by InvestmentNews.

Comparing 17 “full-cycle” nontraded real estate investments trusts with two customized benchmarks, the study found that only five outperformed each of those market indices. That means 70% of the REITs included in the study underperformed the study's customized benchmark — a large part of that due to fees.

The fees on nontraded REITs, which can be as high as 12% to 15%, are particularly egregious, one industry executive said. “An investor gives $100,000 to a program, and he's immediately at $85,000,” said Wes Tellie, director of operational risk due diligence and independent broker-dealer due diligence with Duff & Phelps Corp. “That's a hell of a hurdle rate.”

Although the nontraded REITs in the study posted “respectable total returns,” with an average internal rate of return of 10.3%, that was 140 basis points lower than the two customized benchmarks used in the report.

The benchmarks, one based on a portfolio of properties from the National Council of Real Estate Investment Fiduciaries and the other using broad indexes of publicly traded REITs, returned 11.7%.

The study covers only a small segment of the nontraded REIT industry. While a total of 21 nontraded REITs have had “liquidity events” between 1990 and May 2012, performance for only 17 such REITs was included. That's because the four other REITs have not completed IPOs or other transactions to make them fully liquid.

The study is particularly timely as the initial public offering market for nontraded REITs, known in the industry as a “liquidity event” or “going full cycle,” has heated up this year. Since March, three nontraded REITs have listed on exchanges, with more likely to come.

At the same time, an increasing number of institutional real estate and money managers have taken notice of the money raised in REITs by independent broker-dealers since 1990, the launch of the first nontraded REIT. Such managers are developing new “alternative investment” products for those brokers and advisers to sell. According to an executive summary of the study, the nontraded REIT industry had $84 billion in assets under management at the end of 2011.

The study, performed by consultant BlueVault Partners LLC and the University of Texas at Austin's McCombs School of Business, is likely the first systematic examination of the realized returns for investing in nontraded REITs, according to the report, which was released June 1.

Stacey Chitty, managing partner with BlueVault, did not return a phone call Thursday seeking comment.

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But the study supported Mr. Tellie's claim that fees charged by the trusts zapped returns. “Clearly, the fees associated with nontraded REITs account for performance difference,” the study said. By adding back a standard 12% fee or sales load, the typical annualized return for the nontraded REIT in the study is boosted from 10.3% to 12.5%.

Fee structures of nontraded REITs have increasingly come to the attention of investors and regulators as a number of the largest REITs in the industry have recently struggled with valuations. While some of the illiquid REITs have held relatively steady valuations, other notable REITs have revalued at 25% to 50% less than the original $10 per share that retail investors paid.

Nontraded REITs once gave such investors a great way to invest in commercial real estate. But the market is changing, Mr. Tellie said. “The industry is going through a maturation period because of the recession and other big events," he said. "A lot of programs have turned up dry. Valuations are at a point of a comedy.”

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