Wednesday, November 01, 2017

The Interval Fund Folly

I was at an industry conference last month and was told that there is a double digit number of interval funds in registration. I don't know if this is true, but I have seen plenty of new closed-end funds recently.  I do not understand the enthusiasm sponsors seem to have for these products.  They have better liquidity than non-traded real estate investment trusts and business development companies, which is good.  And the purchase process is easier and the suitability standards are lower than the non-traded products, too, but many broker dealers have implemented suitability standards for interval funds that are similar to those for non-traded products. 

Interval funds offer no deals in terms of fees.  Management fees are based on net asset value and are generally between 1.50% and 2.00% per year, which do not include other fund expenses.  Some interval funds invest in other funds and non-traded products, which have management fees, and potentially carried interest, all of which are in addition to the fees and expenses that the interval funds charge.  This makes a high annual fee hurdle rate that interval funds need to overcome, like 3.00% to 5.00% or more.  Combine these fees with the reality that most interval funds' underlying investments are not high flying investments, but modest return real estate investments, high yield debt investments, and fund investments, and you do not have an outlook for a high returns before any fees. 

Sponsors should check sales figures before entering into the costly interval fund registration process.  Through September, interval funds had raised a net $975 million in 2017, putting them on pace to raise $1.3 billion for all of 2017.  Just two interval funds have accounted for 70% of all sales in 2017.  Yesterday, the DI Wire published an article that says securitized 1031 exchange programs are on pace to raise $1.8 billion in 2017, which is half a billion more than interval funds.  Even the beleaguered non-traded REIT sector, and I exclude the sales of the Blackstone REIT, is on pace to raise $2.6 billion in 2017, or double the money flowing into interval funds. 

Money is leaving interval funds.  Some funds are seeing redemption rates of more than 20% of new sales.  This poses cash management constraints that could further weigh on performance.  Interval funds, in their current form, are not the savior of alternative investments, but an expensive niche investment for clients unsuitable for more sophisticated products.  Sponsors are spending millions to learn this lesson.

Tuesday, October 31, 2017

Four, Twenty, and Two Hundred Forty-One

Griffin Capital Essential Asset REIT announced a new NAV on Friday, October 27, 2017, of $10.04 per share, which was down from $10.44 per share as of October 27, 2016.  The drop in NAV is just under 4% at 3.8%.  This drop in NAV did not come as a shock.   It is only an estimate since the REIT is not traded on an exchange.  The following bullet point from the investor letter accompanying the valuation notice did surprise me:
The decline in NAV from last year stems, in part, from our close working relationship with our tenants as 17 of them (out of 84 properties) provided us with long-term notice related to space use expectations, influenced mostly by corporate mergers and restructurings. These advanced notices will potentially allow us to capture early termination fees which will offset the costs to re-lease the spaces to new tenants under long-term leases while taking advantage of favorable market fundamentals. While we did not include these potential benefits in this current estimate of NAV, we are optimistic that such potential will be achieved and accounted for in future NAV calculations.
The way I read the above passage is that tenants in 17 of the REIT's 84 properties, or 20%, have given notice that they plan to vacate their space.  At least that is how I read the euphemistic statement "provided us with long-term notice related to space use expectations."  Since nearly all of Griffin Essential Asset REIT's properties are single-tenant net leased properties, the REIT is looking at 20% of its properties being vacant.  A reference to the benefits of capturing lease termination fees confirms my thoughts on tenants vacating the properties.  So much for the concept of Essential Assets.

The REIT must spend the lease termination fees to obtain new tenants through lease incentives and improvements.  Since the majority of the REIT's properties are single-tenant, getting new tenants to take an entire building is going to cost the REIT money. 

Griffin Capital Essential Asset REIT had $3.36 billion in total assets as of June 30, 2017.  Its valuation had a estimated advisor promote of a whopping $241,000.  This meager incentive compensation estimate and a big leasing challenge signal to me that this REIT is not going to be seeking liquidity any time soon.

Thursday, October 26, 2017


Hospitality Investors Trust, with the always apt acronym HIT, continues to punch investors.  In response to a tender offer from MacKenzie Realty Capital of $5.33 per share, HIT responded with its own tender offer of $6.50 per share.  What a deal!

HIT throws around a number of percentages in its tender offer announcement.  MacKenzie's tender offer is 58.1% below HIT's most recent NAV of $13.20 per share.  HIT's counter tender offer is only 50.8% below NAV, and it is a 17.5% premium to MacKenzie's offer.  Premium, seriously?  Do not be fooled.  MacKenzie's offer for HIT shares, like all its tender offers, is bottom fishing.  HIT's tender offer seems more like a chance to purchase shares cheap from its own shareholders rather than protect these investors from opportunistic buyers.

There is another percentage HIT does not want you to see.  HIT's tender offer of $6.50 per share is a 74% discount to the $25.00 per share paid by investors.

Wednesday, September 13, 2017

If You're Explaining...

Ronald Reagan said, "If you're explaining, you're losing."  It is a simple statement that has some real truth to it, and it directly applies to all these multiple shares class investments that I have ranted about.  There is an example this morning in a DI Wire article on FS Investment's new non-traded mortgage REIT.  The story devoted two sentences in one paragraph to the REIT's investment thesis, but needed seven paragraphs and about three quarters of the article to detail all the share class options.  I don't think FS is losing yet, but it is sure doing a lot of explaining, which is not good.

Monday, September 11, 2017


Last week I noted First Capital Investment Corporation's (FCIC) dismissal of its auditor and highlighted a passage from the filing disclosing the change.  It looks like the section I noted was on to something, as today the DI Wire is reporting that FCIC's former auditor is disputing FCIC's claim that there was no disagreement on accounting principals and disclosure.  The auditor did take issue with FCIC's affiliated transactions.  Really.  I never would have guessed it.

Ugly, Ugly, Ugly

I was out late last week and am catching up with some news.  This DI Wire story on the legal fight between Vereit and the AR Global executives is ugly, and it looks like it's going to get uglier.  The indemnification clauses that all investments have and that you skim over are now prominently in the open.  Who ever wins in court, it looks like investors are going to get stuck paying a whole lot of legal fees.

Wednesday, September 06, 2017

Own Worst Enemies

I ranted here about non-traded REITs having too many share classes.  This DI Wire article about Black Creek (formerly Dividend Capital) Diversified Property Fund reads like a parody.  The REIT now has seven share classes: A, D, E, I, T, S, and W.  Seriously, it is freaking ridiculous.   Black Creek / Div Cap, it's time to get real:  This REIT can add twenty-six share classes, but the only time it raises money is when it periodically offers shares bribes broker dealers with a big upfront commission.  Instead of wasting investors' time trying to bring in more money, why not just convert everyone to a single liquidating share class (call it Class L, of course!) and get investors the heck out of this dog.

Black Creek Diversified Property Fund is not the only public non-traded REIT I have seen recently offering a nonsensical number of shares classes.  I have even seen one that is adding numbers after letters, like Class A-1.  Hey sponsors, I am not sure who is advising you to offer so many share classes, but the advice is bad.  Yes, Blackstone's REIT has multiple share classes and is raising hundreds of millions, but it is the exception not the rule.  Do not mimic Blackstone until you get wire house selling agreements.  Until then, you are only confusing your product and getting no sales.

Run Away.... NOW!

The DIWire had an article yesterday about First Capital Investment Corporation's (FCIC) replacement of its auditor and its appointment of a new auditor, chief financial officer, and compliance officer.  The following passage from FCIC's 8-K disclosing the accounting change had this passage, with my emphasis added:
During the fiscal years ended December 31, 2015 and 2016 and the subsequent interim period through August 24, 2017, there were no disagreements between the Company and RSM on any matters of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of RSM, would have caused RSM to make reference to the subject matter of the disagreement in its report on the Company’s financial statements and there were no “reportable events” as that term is defined in Item 304(a)(1)(v) of Regulation S-K, except there existed a difference of opinion between the Company and RSM that had not been resolved to the satisfaction of RSM relating to the Company’s investments in First Capital Retail, LLC (“ FCR ”), as further discussed in Item 8.01 of this Form 8-K. Specifically, the Company’s investments in FCR may be deemed to have been transactions with an affiliate under Section 57 of the Investment Company Act of 1940 and/or a transaction with a related party as defined under U.S. generally accepted accounting principles. If either determination were made, further investigation may conclude that such determination, if not reflected in the Company’s financial statements to be filed for the quarters ended March 31, 2017 and June 30, 2017, could materially impact the reliability of the Company’s financial statements for such periods.
The disclosure reads as though the auditor fired FCIC, as it had an issue with FCIC's two loans to affiliates, which are FSIC's only investments.  It is now August and FCIC has not filed a financial report for 2017.  This is a pattern of First Captial.  When it acquired United Realty Trust in September 2015 and renamed it First Capital Real Estate Trust it shortly thereafter fired the REIT's auditor and has not filed a financial statement since.  The lack of financial filings and disclosure is repeating at FCIC.

I am not going to waste anymore time discussing First Capital and its investments other than to state that firing auditors and not filing financial statements are not positive developments.  FCIC, as far as I am aware, is still trying to raise capital from retail investors, and I have heard that one reputation oblivious third party due diligence firm is still writing reports on First Capital's investments.  Do your homework.