Guest Contributor: Non-Listed REIT Liquidity and The Value for an Active Trading Market
By: Mike Stubben, President, Summit Investment Research
Critics of non-listed REITs often cite illiquidity as one of the major drawbacks of non-listed REITs. These same critics fail to mention three key related points.
1. Commercial real estate assets are illiquid by nature. You can’t immediately sell a building or even part of a building for cash like you can the stock of a listed REIT, which behaves more like high yield income stock than a commercial real estate investment. Non-listed REITs, not listed REITs, are structured to mirror the nature of commercial real estate assets.
2. The illiquid nature of commercial real estate and non-listed REITs protects them from the punishing roller coaster of returns experienced by listed REITs. Over the past five years, commercial real estate and non-listed REIT returns have been high and stable, while listed REIT returns have been extremely volatile with low returns experienced in 2013 and 2015.
3. Non-listed REITs are limited liquidity investments, not illiquid investments. Non-listed REITs offer share redemptions to provide investor liquidity, and third-parties offer other liquidity options.
Investors should understand the limited liquidity features of non-listed REITs as well as other liquidity options, and investors and sponsors should understand the value of an active secondary trading market.
Limited Liquidity of Non-Listed REITS
Non-listed REITs have share redemption programs that provide limited liquidity for investors. These share redemption programs have several important features that investors should understand:
1. Annual Redemption Limits: Share redemption programs have annual redemption limits with 5 percent as the most common annual limit. Certain non-listed REITs offer up to 10 percent or even 20 percent annual redemptions, but these are exceptions to the non-listed REIT standard of 5 percent per year. Non-listed REITs also typically have provisions that also limit redemptions to the proceeds received through reinvested distributions.
2. No Redemptions in First Year: Non-listed REITs typically do not offer redemptions to investors in their first year of their investment in the non-listed REIT. Buyers must be prepared to hold their shares for at least one year.
3. Subject to Revision: Share redemption programs can be modified by the board of the non-listed REIT. Non-listed REITs typically offer quarterly redemptions, but certain non-listed REITs affiliated with AR Global have recently revised their share redemption programs to only offer redemptions on an annual basis.
4. Subject to Closure: Share redemption programs can be closed by the board of the non-listed REIT. After the Great Recession, most non-listed REITs shut down their share redemption programs due to a spike in redemption requests above annual limits and the need of non-listed REITs to maintain liquidity in the face of declining operations.
5. Scaled Pricing: Non-listed REITs typically have scaled redemption pricing with increasing redemption prices over time. Investors typically must wait four to five years to redeem their shares at 100 percent of the original offering price paid by the investor.
With the limited liquidity and unguaranteed nature of share redemption programs, non-listed REIT investors need other liquidity options that can provide immediate liquidity at fair prices.
Other Non-Listed REIT Liquidity Options
1. Tender Offers: Several firms make tender offers to investors in certain non-listed REITs. Tender offers are legal offers to purchase a specified number of shares at a specified price. Tender offer prices, however, are significantly below the reported net asset value per share of a non-listed REIT. Tender offer prices can be discounts of 60 percent-90 percent of the net asset value. Tender offers take advantage of investors trapped in non-listed REITs with closed share redemption programs and prey on fear and uncertainty to obtain nonlisted REIT shares at deeply discounted prices.
2. Secondary Trading Markets: Several firms provide opportunities for the secondary trading of nonlisted REIT shares. The secondary market structures range from seller established pricing to auction trading similar to eBay. Central Trade & Transfer, for example, has an auction trading platform. The typical market trading prices are a 15 percent-20 percent discount to the reported net asset value for non-listed REITs with high current distributions or a 30 percent-50 percent discount to the reported net asset value for non-listed REITs with low or suspended distributions. In either case, the pricing of shares sold on the secondary market are significantly higher than tender office prices.
Secondary Trading Markets
Due to their higher trading prices and third-party negotiations in many cases, secondary trading markets represent the best long-term liquidity option for investors when they cannot utilize share redemption programs. Secondary trading markets, however, face two key hurdles for their long-term growth.
First, non-listed REIT sponsors have been reluctant or unwilling to publicize secondary trading markets, despite the long-term value that they would provide for non-listed REITs. With tens of millions of equity still trapped in closed non-listed REITs without redemption programs and rising redemption requests over the past year, sponsors and investors would benefit from publicizing and supporting secondary market transactions as a means of providing liquidity for their investors. Sponsor support is important for the long-term growth of the secondary market.
Second, lack of transparency on non-listed REIT performance and valuation keeps many investors out of the secondary market. Unfortunately, history has shown that many non-listed REIT values were inflated and did not accurately reflect market values. Inland Western, which is now Retail Properties of America, is just one high profile example of inflated net asset values reported by the sponsor. Third-party resources providing performance and valuation data are essential for the long-term growth of the secondary market.
The Value of an Active Secondary Trading Market
Liquidity goes hand-in-hand with volatility. Highly liquid investments will have volatile pricing, while limited liquidity investments will have more stable pricing. Non-listed REITs are an effective way for investors to get access to commercial real estate investments in a structure most similar to commercial
real estate. Non-listed REITs, however, need to maintain their limited liquidity through the continued use of share redemption programs and the expansion of the secondary trading market for non-listed REIT shares of closed non-listed REITs. An active secondary trading market would provide expanded liquidity for non-listed REIT equity and increased transparency on non-listed REIT performance, which are two important benefits to investors.
Editor’s Note: The article was originally published in Mountain Dell’s Quarterly Exchange newsletter and was reprinted with permission.
