Wall Street continues to intensify its loving gaze on the once homely and overlooked domain of independent broker-dealers and the hot alternative investments those firms are selling, this time nontraded real estate investment trusts.
And why not? The street has at last come to appreciate the ability of independent broker-dealers, including industry giants such as Ameriprise Financial Services Inc. and LPL Financial, to raise billions of dollars for their deals.
Most independent broker-dealers have platforms for brokers and financial advisers that lack proprietary products. These firms and their clients need sophisticated investment products that promise some yield in an economic environment where traditional investments such as short-term bonds and bank certificates of deposits produce zip.
Independent broker-dealers are on their way to selling $20 billion in shares of nontraded REITs this year, about double the total for 2012, according to investment bank Robert A. Stanger & Co. Inc.
The symbiotic relationship between those REIT sponsors and independent broker-dealers has never been more pronounced.
LPL Financial last month reported a booming increase in commissions in the third quarter for nontraded REITs and other alternative investments. For the three months ended in September, commission revenue for alternative investments at LPL increased a staggering 160.1%, reaching $81.2 million.
This column recently has focused on the phenomenon of Wall Street cozying up to independent broker-dealers.
In April, I drew attention to how even the mighty The Goldman Sachs Group Inc. was
chasing independent financial advisers and hybrid brokers through a partnership with the CAIS Group, an exchange for alternative investments such as hedge funds and private-equity funds.
Private-equity giants KKR & Co. and The Blackstone Group are managing billions of dollars of private-loan portfolios in nontraded business development companies sold by independent representatives at Ameriprise, LPL and others.
Now, in a highly unusual development, a large traded REIT, Starwood Property Trust Inc., (STWD) this month made a direct investment of $250 million into a nontraded REIT, the Griffin Capital Essential Asset REIT Inc.
Starwood bought 24.3 million preferred shares of the REIT. (A tip of the hat to the mystery blogger Rational Realist for bringing this transaction to light.)
Kevin Shields, chief executive of the Griffin Capital Essential Asset REIT, said that the transaction was unusual.
“I think it's the first time this has ever been done, that I'm aware of,” he said. “It's a first for a nontraded REIT, while in its offering stage, to also raise preferred equity.”
The $250 million that the REIT raised was used as one part of the financing for the $521.5 million purchase of 18 office properties in 11 states. With this acquisition, the REIT now owns 41 properties with a total capitalization of $1.3 billion.
For the first year, the preferred shares will pay the London Interbank Offered Rate, plus 7.25% of the redemption price of $10.28 a preferred share. Then, through 2017, the yield will increase 100 basis points a year; starting in November 2018, and each year after, the yield increases 5% per year.
“You would think you would have more of these kinds of investments into nontraded REITs. I'd love to do more of it,” Mr. Shields said.
“I'm not surprised, given the pace of equity being raised in the [nontraded REIT] space,” he said. “That tends to attract some institutional attention, and all the things that American Realty Capital has done successfully has attracted positive attention to the industry and put the space on the map.”
ARC chief executive Nicholas Schorsch entered the nontraded REIT industry aggressively in the aftermath of the financial crisis and worked to address flaws in the product.
Most importantly, he has dramatically shortened the expected lifespan of such REITs, which in the past lived on for years and continued to raise capital after an expected closing.
For example, Mr. Schorsch and his team at ARC created a “liquidity event” for American Realty Capital Trust III in February, less than two and a half years after it was first registered with the Securities and Exchange Commission.
And the REIT posted strong returns for investors.
According to Stanger, ARC III's shares were sold at $10 and posted an internal rate of return of 27% through last month.
The nontraded REIT industry and the broker-dealers that sell their products are sitting on a mountain of money, with up to $45 billion in REITs preparing for liquidity events in the next few years. Much of that money will flow to new nontraded REITs, particularly as clients continue to look for yield amid record-low interest rates.
And that potential flow of cash has gotten Wall Street's attention, Mr. Shields said.
“This year's $20 billion [in nontraded REIT sales] won't be an anomaly,” he said.
