With 2015 just over a week away, the direct investment industry is poised for another exciting year. From upcoming liquidity events to FINRA’s NAV rule change to ARCP’s industry-rattling accounting scandal, we enter 2015 with not a dull moment.
Jacob Frydman, Chairman and CEO of alternative investment sponsor, United Realty, offered some observations and insights for the year ahead.
For starters, he explained that interest rates are rising and with that, capitalization rates will rise too.
According to Mr. Frydman, the majority of non-traded U.S. REITs have portfolios that are mostly comprised of single-tenant credit leases with little or no rent increases, a scenario that does not bode well for investors.
“When real estate that is subjected to a single tenant credit lease with no rent increases sees cap rates rise, the value of those assets falls,” said Mr. Frydman.
He explained the importance of having an asset manager that knows how to extract the most value out of assets, for example by implementing rental increases. “That’s what active management is all about,” he added.
Another impactful change that will manifest in 2015 is FINRA 14-06, a rule which changes how companies state the value of non-traded REITs and direct participation programs.
When discussing the rule, Mr. Frydman explained that most REITs are sold based on anticipated results rather than performance and that FINRA 14-06 will have positive effects in terms of transparency to investors.
“Performance is going to become much more important,” he opined. “It [FINRA 14-06] is great because it is transparent and gives the investor a real look into what the value of the underlying assets is and more importantly, from my perspective, it makes sponsors accountable.”
Mr. Frydman also predicts that the rule change will lead to new types of commission structures that will be more investor friendly.
Lower upfront sales charges may become more important as a number of non-traded products become eligible for liquidity events over the next year. Investors will be faced with deciding what to do with their capital and whether or not to funnel it back into the industry.
“A lot of it would probably get reinvested into the space so the opportunity for financial advisors and investors is to consider how to reinvest it. Should they reinvest it with the same sponsors they were invested with before or should they consider other sponsors?” remarked Mr. Frydman.
Mr. Frydman also predicts a decline in values of brick and mortar retail stores in rural and suburban areas as a result of online shopping’s increased popularity. Additionally, he foresees a potential dislocation in the commercial mortgage backed securities (CMBSs) market due to a change he suspects will take place in how credit reporting agencies rate CMBS bond issuances in 2015.
In regards to ARCP’s recent accounting errors, Mr. Frydman commented, “It could end up being a blip and not having any impact or it may be impactful based on what’s ultimately discovered.”
Mr. Frydman praised American Realty Capital’s innovative contributions, which have helped the industry grow to its current size. He shared, “My hope is that it clears up and that there’s no issue because I don’t think it’s good for the industry to have these types of negative externalities.”
United Realty has noticed an increase in sales activity, although whether or not it is related to AR Capital’s and Cole’s suspensions on some broker-dealer platforms is unknown.
“I don’t know that I can pinpoint it to a specific event but I know that we have been talking about the risks associated with interest rate increases and cap rate increases that we believe are coming as a result of anticipated interest rate rises, and I think that that message has resonated and I think that has been a primary reason that we have seen our sales increase,” said Mr. Frydman.
“I am delighted whatever the reason is that this has given United Realty new independent broker-dealers joining our selling group and increased interest in our products,” he added.
To learn more about United Realty, click here.