REIT values are up, but so is skepticism

The nascent rebound in the commercial real estate industry has allowed a handful of nontraded real estate investment trusts to increase their valuations this year. But some industry experts greeted the higher values with a degree of skepticism, saying that, if nothing else, they point to an overall problem in valuing REITs. The national all-property composite of Moody's/RCA Commercial Property Indexes was up 0.5% in June, the most recent month for which data were available. The composite rose 10.3% for the 12-month period ended June 30. In August, TNP Strategic Retail Trust Inc. raised its estimated per-share value to $10.40, from $10.18. In April, the Strategic Storage Trust said its per-share net asset value, or NAV, had risen to $10.79 — 79 cents above the standard offering price of $10 a share. The same month, Industrial Income Trust Inc. said its per-share NAV had risen to $10.40, from $10. In July, the Steadfast Income REIT said its estimated NAV was up to $10.24, from $10. At the same time, it said that investors will pay $10 per share until next Monday, when the $10.24 per-share value will take effect. The increases are noteworthy as the $10 billion a year “direct participation program” business grapples with nagging bad news about large nontraded REITs that recently have seen valuations fall, at times dramatically. A trade group, the Investment Program Association, is working to create industry standards for REIT valuations, which have been under scrutiny by the Financial Industry Regulatory Authority Inc. since February 2009.

TIMING WAS RIGHT

The four REITs seeing value improve bought property during and immediately after the real estate crash. Their valuation methods vary, however. Some use an outside appraisal, while others leave it to the discretion of the board, which then asks a third-party firm “to review the assumptions and methodologies applied” to determine the valuation. Asked about the increase in the REITs' valuations, Jeff Young, senior vice president with the brokerage firm First Financial Equity Corp., said: “I look at those numbers with a skeptical optimism. “In general, it's very difficult to come up with a valuation” for a REIT, he said. “We're happy with it, but don't hang our hat on it.” Mr. Young said he would like the nontraded REIT industry to standardize valuation procedures in some way. “In fairness to the companies, [this issue was] put on their plates by the regulators in the last few years,” he said. Valuations are often called “snapshots in time” by industry executives, who emphasize that they will change over a REIT's life. “But it's better in that direction than the other,” Mr. Young said, adding that First Financial has selling agreements with each of the four REITs to which this story refers. An announcement of an increase in share value weeks before it takes effect could create pressure for sales, one REIT executive said. “We love the idea of revaluing” nontraded REITs, said Nicholas Schorsch, chief executive of American Realty Capital. “The real issue is, why tell people you're going to sell at a higher price 60 days in advance?” The rise in valuations is “positive, but short-term sales bumps are problematic,” Mr. Scorsch said. “It's a point-of-sales issue. It's that lag, which is dilutive to the existing loyal investors in the REIT.” “If the value is $10.30 but you sell it at $10, the value is diluted,” he said. “Existing shareholders are at a disadvantage because [advisers] are selling a higher-valued REIT at a lower share price.” One broker-dealer, American Portfolios Financial Services Inc., suspended sales of the Steadfast Income REIT in July in order to review the methodologies behind its revaluation. “We have the highest regard for Steadfast, and have a very good relationship with them and other REIT sponsors,” said Frank Tauches, general counsel for American Portfolios. “We want to make sure that any decision made on pricing a security was made in a sound, acceptable manner.” Steadfast Income's board determined its new estimated NAV and “relied upon information provided in a report” by its adviser, Steadfast Income Advisor LLC, according to a filing with the Securities and Exchange Commission. The board also “engaged Duff & Phelps LLC to review the assumptions and methodologies applied by our adviser in accordance with a set of limited procedures,” the filing said. “Nothing in Duff & Phelps' report caused our board of directors to question the reasonableness of our adviser's valuation of our real estate investments,” it said. “Steadfast has been an advocate for increased transparency in the nontraded REIT space, and feels that thorough due diligence always benefits the investment process,” the REIT's CEO, Rodney Emery, wrote in an e-mail. “In this highly regulatory environment, we respect any broker-dealer's decision to proceed with an abundance of caution” and perform a review after the change in the REIT's estimated NAV, he wrote. “Approximately 50% of our business comes from qualified accounts with extensive account transfer times,” Mr. Emery wrote. “The 60-day period between the announcement of the estimated [NAV] per share and the share-price change was determined to be a reasonable period for us to communicate this valuation with our selling group, and to give firms and advisers enough time to evaluate the change on behalf of their clients.” Companies' use of outside firms to create revaluation estimates varied. Industrial Income Trust used Duff & Phelps “to conduct an appraisal of all our real estate assets” bought before fourth-quarter 2011. Strategic Storage Trust “engaged Cushman & Wakefield Western Inc. to provide an appraisal” of the portfolio's properties, according to a filing with the SEC. The REIT said in a press release that the revaluation was “based predominately on an appraisal” of its 91 self-storage properties. The board of TNP Strategic Retail Trust determined its valuation but also used Duff & Phelps “to conduct valuation consulting services regarding all our real estate assets,” according to an SEC filing.

BOARD'S INPUT IMPORTANT

A board's input on a REIT's valuation can carry weight because of members' knowledge and expertise, industry observer said. “The valuation is not something we pull off the shelf,” said Jim Wolford, chief financial officer of the TNP Strategic Retail Trust. “We spend a lot of time with experts in the market and then run it by Duff & Phelps to see if they agree with the analysis.” An independent appraisal each quarter of the REIT's properties would be prohibitively expensive, Mr. Wolford added. “We felt it was important to bring in a third party to do an independent appraisal,” said Michael Schwartz, CEO of Strategic Storage Trust. “Cushman's appraisal was 95% of the valuation and was of the REIT's wholly owned assets,” he said. The remaining 5% was done internally by the company and focused on “investments in smaller, limited-partnership-type investment,” as well as evaluation of debt, he added. “We followed pretty tightly some preliminary guidelines the IPA has been disseminating on valuation,” Mr. Schwartz said. bkelly@investmentnews.com Twitter: @bdnewsguy