Radical Departure: The Latest Non-Listed REITs Offer Enhanced Liquidity, Transparency

One of the commercial property industry’s best-known institutional investment managers is now also striving to sell warehouses through wirehouses. In a move with potentially far-reaching implications for the ever-controversial non-listed REIT sector, the renowned real estate advisor Clarion Partners is aiming to sell shares in the new REIT the company is sponsoring to individual investors through financial advisers.

By Brad Berton

One of the commercial property industry’s best-known institutional investment managers is now also striving to sell warehouses through wirehouses. In a move with potentially far-reaching implications for the ever-controversial non-listed REIT sector, the renowned real estate advisor Clarion Partners is aiming to sell shares in the new REIT the company is sponsoring to individual investors through financial advisers.

Key features of the Clarion Partners Property Trust REIT arguably represent a radical departure for the non-listed space, which has traditionally been characterized by hefty commission loads, unclear share valuations and scant liquidity. CPPT and at least a couple of other new trusts now in registration are structured to give shareholders more transparency with daily value calculations, improved liquidity with more liberal redemption options, and in some cases lower up-front sales commissions and ongoing management fees.

Not only do these more shareholder-friendly features address issues that investors and regulators have lamented for years, they are also aimed at boosting capital-raising prospects by broadening the networks of financial advisers interested in selling new issues.

With new non-listed REIT issues exceeding investor demand, at least for the moment, industry experts say Clarion and the other well-known sponsors offering the newfangled products are logically targeting financial advisers at the big so-called “wirehouses”—large branch networks bearing household names such as Morgan Stanley and Merrill Lynch.

“If they get these big firms on board, they’ll generate a lot of business,” predicted Timothy MicKey, lead portfolio manager for structured products and alternative investments with financial planning firm Monument Wealth Management.

Indeed, a quartet of mega-wirehouses alone —Bank of America Merrill Lynch, Morgan Stanley Smith Barney, Wells Fargo Advisors and UBS Financial Services – collectively control a 38 percent share of some $13.5 trillion in U.S. brokerage and advisory client assets under management (as of the beginning of 2011), according to research firm Aite Group.

Hence, if CPPT’s structure attracts an impressive chunk of this capital—and the trust throws off solid cash flows via dividend distributions—it stands to reason that other institutional advisors would look to replicate the model, MicKey and others agreed.

Experts also stress that emerging strategies at Clarion and other forward-looking REIT sponsors entail catering to the growing ranks of financial planners being compensated more through annual asset management fees than up-front sales commissions. The new trusts’ revised adviser compensation options reflect the effort to woo intermediaries preferring fee-based arrangements.

Non-traded REITs are registered with the Securities & Exchange Commission but not listed on public stock exchanges. Sponsoring organizations such as Wells Real Estate Funds, Inland Real Estate Group, Behringer Harvard Holdings, CNL, Grubb & Ellis and W.P. Carey & Co. sell shares (mostly at $10 per, initially) in new trusts primarily through independent-contractor broker-dealers.

Investors receive dividend income but traditionally have little opportunity to sell shares before management opts for an ultimate exit years down the road, through such means as a portfolio sale, public offering or liquidation. Standard practice for non-listed REITs has been to buy back only 5 percent of a given trust’s shares each year, on a first-come/first-served basis.

And only in the past few years have regulators required sponsors to report updated portfolio values on a net-asset-value-per-share basis —and then only every 18 months.

Up-front sales commissions and fees in the sector have tended to be far higher than with most other investment categories—with investors typically covering a 7 percent sales commission plus dealer-manager fees amounting to another 3 percent. Of course, the investor dollars paid off the top as commissions are not used to acquire real estate.

But as more and more financial advisers come to adopt the “managed account” compensation platform rather than transaction-based commissions alone, a few enlightened REIT sponsors are seeking to structure new trusts to appeal to them with fee-based sales compensation options. And as these fee-based advisers also tend to prefer vehicles offering enhanced liquidity and regular valuation calculations, CPPT and a couple of other trusts in registration aim to redeem as much as 20 percent of outstanding shares annually, based on daily NAV calculations.

These new structures seen with CPPT and in-registration trusts from major sponsors American Realty Capital and Cole Real Estate Investments will likely influence future offerings—that is, if their managements are able to squeeze solid incomes from their portfolios, said Vee Kimbrell, managing partner with non-listed REIT analyst Blue Vault Partners.

“I think they’re great structural enhancements for the (non-listed REIT) product category,” Kimbrell related. “Better liquidity is what these new product designs are ultimately aiming for.” As redemptions are priced at regularly calculated NAVs per share, the clearer and more timely portfolio valuations should likewise attract more investor capital, she continued.

And with the more deliberate targeting of fee-based financial advisers, the non-listed space’s notoriously high commission rates seem destined to decline, Kimbrell added.

Another attractive structural feature of the newfangled Clarion, ARC and Cole offerings is that they are so-called perpetual-life REITs—that is, shares can be purchased at the prevailing NAV price, and the trusts have no targeted exit strategy. Indeed, that feature is something akin to the open-end commingled investment funds Clarion and other top-tier advisors manage on behalf of mostly institutional investors.

“They’re structured more like open-end mutual funds,” observed Nancy Schabel, who crunches industry data at specialty securities valuation firm Robert A. Stanger & Co. “You buy them at net asset value (per share) and have some ability to redeem on a daily basis.”

“It’s coming closer to mirroring what we see in the institutional money management arena,” agreed Kimbrell.

The inaugural Clarion Partners REIT, which got its much-anticipated “effective” declaration from the SEC in mid-May, is targeting a variety of income-generating real estate investments across the country. CPPT will issue two classes of shares: one featuring a 3 percent up-front sales commission (31 cents added to the targeted initial $10 share price); the other paying a small annual adviser fee. Once the trust becomes operational, shares can be redeemed and sold at an NAV-per-share price adjusted daily. Redemptions of as much as 5 percent of CPPT’s NAV will be funded each calendar quarter.

And unlike many managers of non-listed REITs, Clarion will not charge shareholders transaction fees each time a property is purchased, sold or financed—although it will seek to pass through to shareholders any legitimate associated third-party costs.

Neither of the other, similarly structured REITs in registration, sponsored by two of the biggest brands in the non-listed space today, had received its SEC effective declaration as of press time.

As its name suggests, American Realty Capital Daily Net Asset Value Trust mirrors CPPT’s policies with respect to valuation transparency and daily liquidity. In a late-July letter to SEC officials, ARC outside counsel Peter Fass stated quite clearly that the REIT “has been structured to address well-known shortcomings associated with traditional non-listed REITs, principally: (1) lack of liquidity; and (2) the rigidities implicit in a closed-end, fixed-price investment.”

This REIT’s commission structure, however,  differs in that one of its two share classes is still subject to a fairly hefty traditional sales commission structure. Retail shares will be sold with a 10 percent commission, putting the “total” target initial share price at $9.90 ($9 plus a $0.90 commission). Institutional shares will be sold without upfront commission but be subject to an annual “platform” fee.

Also in registration is Cole Real Estate Income Trust, which aims to invest in net-leased retail, office and industrial properties. It likewise offers limited redemptions at the daily NAV per share, and SEC filings indicate management intends to compensate financial advisers via ongoing fees only—meaning investors will not end up funding up-front sales commissions.

If these first few newfangled REITs perform well and attract capital, it is logical to assume the non-listed REIT sector will tend to gravitate toward lower up-front fees and quarterly or even daily redemption options, Kimbrell suggested.

And given the ongoing low-interest-rate environment, chances are a lot of investors will be striving to shift from minimal-yielding investments to non-listed REITs. Despite their controversies, these vehicles offer steady dividend income and allow for appreciation of portfolio property values, while still avoiding daily fluctuations of the public stock markets.

The sector now boasts some $75 billion in assets under management—and counting. Another dozen or so equity-oriented trusts are currently in registration, aiming to supplement the non-listed universe’s existing 40-plus such REITs, Schabel calculated.

Capital raising peaked in 2007 at about $11.5 billion, declining to $6.1 billion in 2009 but rebounding to $8.1 billion last year, she specified. Through the current year’s first six months, the pace was even stronger at $4.5 billion.

While MicKey still has some concerns relating to liquidity and dividends, he sees the new strategies as generally positive for the non-listed sector. “The industry is changing for the better,” he concluded.

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