First-time study recognizes growth in industry and also levels criticism.
While lagging publicly traded real estate investment trusts in performance, nontraded REITs that have had liquidity events, meaning a listing on an exchange or a merger, have still produced sound results, according to a new report.
The average annualized, dollar-weighted returns for the nontraded REITs with liquidity events was 10.9%, according to the report from Green Street Advisors, which was published at the end of August. That's compared to annualized dollar-weighted returns of 14.5% for listed REITs within the same property type and over the same lifespan of the nontraded REIT, according to the report.
Since 1990, 34 nontraded REITs have experienced liquidity events, with those REITs raising $54 billion in equity, which is about half the total capital raised by all nontraded REITs, the report said.
The Green Street study is notable because it is the first to track nontraded REIT performance in comparison with their traded counterparts, industry executives and analysts said. Green Street Advisors has traditionally focused on traded REITS and has, for the most part, ignored nontraded REITs.
“The listed REIT community has said that nontraded REITs don't stack up as well, with the reasoning being that, when you take 15% off the top [in fees] you can't keep up,” said Jim Sullivan, managing director with Green Street Advisors. “Until we did this study, you couldn't tell. The sample set [of nontraded REITs with liquidity events] hadn't been big enough.”
Mr. Sullivan added: “No one has done [this type of study] before. It quantifies what had been a gut thesis on relative performance. And it's interesting that there are some heroes — some nontraded REITs that outperformed. The characteristics of those shed light on the topic.”
“The thing that is getting people's attention about the study is the impressive results,” said Kevin Hogan, chief executive of the Investment Program Association, an industry trade group. “There are 34 deals that have gone full cycle with an [internal rate of return] of 10.9%. [That is] actually something the industry is getting excited about, and rightly so.”
“The study shows nontraded REITs are a real product,” said Nicholas Schorsch, chief executive and chairman of American Realty Capital, the largest nontraded REIT sponsor. “Liquidity has come in to the industry, but it's not the liquidity but actual performance that matters to investors. There's now a big enough cross section [of nontraded REITs] for such a study, and there's likely another 30 deals [expected to have liquidity events] in the next three years.”
The nontraded REIT industry has seen tremendous growth in the past five years. Sold almost exclusively by independent-contractor broker-dealers, nontraded REITs are on pace for their second consecutive year of raising $20 billion in equity, “which represents a quantum leap from the $8 billion per year pace they achieved from '03-'12,” according to Green Street.
The study, however, did not hold back its criticism of the nontraded REIT industry. “The shortcomings of NTRs, especially compared to publicly traded REITs, are consequential and numerous,” according to Green Street. Those include “massive front-end loads” of 12% or more and outsized fees for buying and managing properties.
“Digging deeper, however, the results shine a light on why the NTR industry is healthier than ever,” according to the study. The “solid results … are good enough to keep investors who aren't aware that a rising tide lifts all boats coming back for more.”
Results have improved recently, with nontraded REITs that have had liquidity events seeing better performance than earlier, with six out of the last 11 outperforming their traded REIT counterparts, according to the report. And some sponsors “have racked up multiple wins,” according to the report.
Those outperformers include American Realty Capital, with three of five nontraded REITs besting their listed peers, and ironically, two of five Apple REITs, sold exclusively by brokers affiliated with David Lerner Associates Inc. In 2012, the Financial Industry Regulatory Authority Inc. ordered David Lerner to pay close to $12 million to clients who bought into Apple REIT 10 and to those who were charged excessive markups. At the time, Finra also suspended the firm's founder, CEO and namesake, David Lerner, for a year.
Indeed, by focusing on a property sector where net asset value premiums for listed REITs are very large, nontraded REIT sponsors have developed “a surprisingly simple formula for builds NTRs that have a good chance for outperforming traded REITs,” according to Green Street.
“Five of the six NTRs that raised their capital when their respective listed sector peers were trading at premiums in excess of 30% bested those peers, which compares to a 10% success rate when premiums were below 30%,” according to Green Street. “Big NAV premiums in the public space don't ensure success of an NTR, but they greatly increase the odds.”
