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.

Tuesday, September 05, 2017

Hines Global II Goes NAV

Hines Global REIT II, which had raised $368,000,000 through July over its almost three-year offer period, is converting to a NAV REIT.   In filings last month, the REIT announced that it will commence a $2,000,000,000 secondary offering, publish a net asset value monthly, and have a perpetual life.  The REIT declared an NAV of $9.65 per share in February 2017.  Hines Global REIT II is eliminating acquisition and disposition fees, which is postive.  "Perpetual life" means that the REIT no longer has an expected term or a plan to provide liquidity through a listing, merger, or asset sale.  Investors that want to liquidate their shares must submit their request through the REIT's share redemption program (SRP).   The REIT's SRP has been expanded to allow for monthly redemptions of 2% of NAV, subject to a redemption cap of 5% of NAV per quarter.  The REIT can suspend, modify, or terminate its SRP at anytime.

NAV REITs are not a bad idea.  They allow their managers to take a long investment view instead of buying investments that fit into a targeted exit period, and a perpetual offering provides for capital inflows and investments over various investment cycles, lessening the seasonality of investing in a particular market, which occurs when money is raised and invested within a specific market cycle. There is no preclusion from Hines Global II having a future liquidity event, but it is no longer management's primary exit strategy.  In steady markets, redemption requests should be processed without an issue.  But NAV REITs will face a test when markets are unsettled, or even if there are specific REIT-level events and redemption requests exceed the monthly limits.  Based on the 2% monthly and 5% quarterly caps, significant requests for liquidity could hinder a REIT for years.

My complaint with Hines Global II's decision is not that it is restructuring as a NAV REIT, but that when investors purchased their shares in the REIT they were not expecting a perpetual life REIT, but an investment that would provide some form of liquidity in eight to ten years from when the REIT's offering started in 2014.  The REIT's investment objective and business plan are being changed because of Hines's failure to raise capital.  If the REIT had raised $1,368,000,000 instead of $368,000,000, there is no way it would be converting to a NAV REIT.

I understand market conditions change, but real estate markets have not changed that much since Hines Global II began raising capital in August 2014.  Interest rates and cap rates are still low, the U.S. economy is still growing, and Europe's economy has improved.  Outside of older, Class B or lower regional malls, most real estate assets classes are as strong as they were in 2014.   What has changed is non-traded REITs' ability to raise capital.  Until that is figured out, every REIT needs to add disclosure about the possibility of becoming a NAV REIT.

Friday, August 11, 2017

Distribution Cuts and Verbal Sparing

It is time to take a trip deep into the woods.  I recommend reading the transcript of yesterday's FSIC earnings call.  FSIC announced a distribution cut of about 14%, dropping the quarterly distribution from $.22 per share to $.19.  FSIC is waiving .25% of its asset management fee for a year as a partial offset, which is about the same percentage reduction as the distribution.  FSIC blamed the distribution drop on a borrowers' market and "non income-producing equity" investments from restructurings.  Non income-producing investments from restructurings are former income producing debt investments that are now equity investments.  There was no discussion as to how the value of the new equity positions compares to the FSIC's original debt investments.

I am seeing across various income oriented BDCs and mortgage REITs that spreads are tightening, which means that the returns on the riskier assets these funds specialize in are dropping.  The situation is not unique to FSIC.

In an almost casual comment at the and of his prepared statements, FSIC CEO and Chairman Michael Forman stated that FSIC's "board is evaluating the timing and benefits of a merger with FSIC II, which remains a key focal point and could be a 2018 event."  This is news.  There is no date or definitive announcement, but a merger that remains liquid is positive news. 

The sparing is between FSIC management and Wells Fargo analyst Johnathan Bock and came during the question and answer session.  Bock questions the value of Franklin Square in the relationship with GSO as sub-advisor, wondering, "Of the deals that GSO submits to you, how many deals either early or late in the process do you at FS reject, given you are the final investment authority?"  Basically, he is wondering what Franklin Square does to earn a portion of the management fee because, according to Bock's implication, GSO does all the work.  FSIC does not directly answer his question in several answers from its executives, choosing to instead focus on the collaboration between FS and GSO.  Bock gets the final word by questioning FSIC's commitment to transparency as stated on its website. 

Do not think it random that Corporate Capital Trust abandoned its advisor / sub-advisor relationship before its planned listing. 

Thursday, July 27, 2017

Money Where Your Mouth Is

W.P. Carey closed its syndication business at the end of June, citing high prices for net lease real estate as a reason.  According to Carey, offering its real estate investment trusts no longer made sense due to low cap rates, which means that net lease real estate is too expensive to buy and the yields too low.  I am going to call baloney on this excuse.   If Carey believed its rhetoric it would be either selling the entire company to maximize shareholder value to take advantage of the high net lease values, or it would be selling individual properties or portfolios in particular low cap rate sectors.  I have not read an announcement that Carey is looking for strategic buyers, and its property sales listed in its most recent 10-Q appear incidental.  Two the four listed dispositions in the first quarter involved giving properties back to the lender, not a real estate company's favorite type of disposition, and not the moves of a company capitalizing on a strong market.  Carey did not buy any meaningful real estate, either.

Carey had a unique syndication business.  It was conservative in its approach to managing its real estate funds - favoring long-term mortgages and not the tempting, low interest, variable rate lines of credit adopted by so many sponsors to increase near term cash flow - and its sales team was always professional.  Carey's core REIT product had some of the highest up-front fees in the industry along with some of the lowest ongoing fees.  This runs against today's market, which wants lower up-front fees so that investor's initial statement values do not differ too much from the share price investors paid for their shares*. 

It is my opinion that Carey, as a listed company, expected to make a certain amount of revenue and profit on the high initial fees of its syndication business, and likely built this revenue into its earnings estimates.  I suspect that Carey was unwilling to adapt to products that provided it less up-front revenue and short-term profit, even if it meant foregoing greater profit potential over time.  If it lowered its initial fee income Carey would have to lower earnings estimates, a task loath to any company.  I have been hearing that net lease real estate is too expensive for years, since at least late 2013 or 2014.  Maybe it is, heck, it probably is, no one knows for sure.  Until Carey puts itself up for sale, or sells large portions of its portfolio, I will stick with my opinion that Carey was unwilling to lower up-front fees and that is why it exited the syndication business.

*For example, an investor buys shares listed at $10.00 per share.  With a traditional front end cost of, let's say, 11%, an investor that bought shares at $10.00 would get an first statement showing a real value of $8.90.  Sponsors have been lowering, paying, deferring, and reclassifying costs to bring the statement value up to a more investor palatable price, which are discounted 4% to 6% ($9.60 to $9.40 per share) rather than the 11%.