Over the last two years, nontraded REIT liquidity events have totaled more than $21 billion and we see nearly $20 billion worth of additional events on the horizon — with some of the most successful likely contributing to the record nontraded REIT capital-raising that occurred since 2012.
(See Bruce Kelly's take on the summer of liquidity events.)
The best type of liquidity event is when nontraded REIT investors tend to make a profit on their initial investment. Traditionally, liquidity events were often engineered to create an exit for the sponsor, not the investor. The new dynamic of liquidity events reflects a greater emphasis on investor total return and a timeline for return of principal, rather than just income from yield. They are increasing because publicly-traded REITs and nontraded REITs are, in a sense, coming together.
Most liquidations happened in one of three ways:
1) An IPO into the REIT public market
2) A sale to an affiliated publicly traded REIT
3) A sale to a REIT sponsor that is a publicly listed company
Because nontraded REITs are booked at cost and not revalued for many years, it was difficult for investors to understand their true total return. But liquidity events have created some price transparency. With it, REITs can compete on something more than their headline yield, marketing story and sponsor distribution power. Now, many internalization fees are replaced by sponsors making money off of units and performance fees, making them more aligned with investors' gains.
Assuming $0.50 of every dollar is recycled, liquidity events have contributed to 30% of the total capital raised in just the last two years. When clients receive both the yield and hopefully their principal back — with some potential profit — it benefits the adviser, who also covers their fee if the price is above the original issue price. This encourages the recycling of much of the capital back into the nontraded REIT market, furthering the positive economic dynamic for the advisors and sponsors.
So where are liquidity events going?
I am of the opinion that speedy liquidity events “above $10” are becoming less prevalent and premiums are diminishing. My reasoning is simple — nontraded REITs had been acquiring assets at the low point in the real estate cycle and liquidating into a REIT market trading at a premium valuation.
Today we are at a more advanced stage of the real estate cycle where values have appreciated and yields have fallen. We have also seen a decrease in the valuation of many of the net lease publicly traded REITs, the asset type that represents approximately two-thirds of the nontraded REIT market, due to concerns about higher interest rates. While the listed REIT market may provide better opportunities ahead, it is difficult to create a defined exit strategy based on unpredictable future REIT market valuations. Instead, investors should be prepared to stay in non-traded REIT programs longer and focus on the attractiveness of the investment, rather than an early exit.
The introduction of greater transparency of the value of clients' investments in nontraded REITs, with the introduction of Finra Rule 14-006, will drastically change the focus of investors by providing a much clearer picture of the value of their investments and the performance of the nontraded REIT manager. Clients will see their investment value net of fees and commissions. In addition, quicker and more frequent valuations will reflect any return of capital through distributions and valuation movement in the underlying real estate.
The creation of a true “price” in the nontraded REIT market not only gives investors important information but will allow for a focus on the manager's performance and total return, rather than marketing, liquidity events and uncovered headline yields. A price mechanism is one of the most important aspects of a market and the introduction of a clearer picture of value has the potential to further improve the nontraded REIT space for investors.
Scott Crowe is a portfolio manager for Resource Real Estate