Non-traded REITs are facing a number of headwinds that have created a drag on fundraising success.
Since peaking at $19.6 billion in 2013, fundraising among public, non-listed REITs has dropped significantly in the past two years. In 2014, fundraising fell to $15.6 billion, followed by another sharp decline last year to $10.0 billion, according to data from Robert Stanger & Co, an investment banking and financial advisory firm. The company is forecasting another dip this year to between $7.0 billion and $8.0 billion.
The deceleration in fundraising can be attributed to a combination of factors. One is a shifting tide in successful liquidity events, which helped to bolster reinvestment in the past three years. In the past 12 months, the rollover of funds has slowed down, in part because results have been less robust as the real estate cycle has matured.
Other hurdles impacting fundraising include the lingering effects of an accounting scandal that has embroiled one of the leading firms in the space, as well as new regulatory requirements set to go into effect in April that will make fees more transparent.
American Realty Capital has received a tremendous amount of attention for the “crashing and burning” of its empire, says Jim Sullivan, a managing director at Newport Beach, Calif.-based research firm Green Street Advisors. The firm, which had been a top capital raiser in the sector, suspended its fundraising in November. Even under that cloud, it still succeeded in grabbing the most market share in 2015 by raising $2.3 billion—accounting for 23.5 percent of the total capital raised in the sector, according to Robert Stanger & Co.
Other negative news surfaced late last year when hedge fund Hayman Capital made allegations that Dallas-based United Development Funding (UDF) was exhibiting characteristics consistent with what it referred to as a $1 billion “Ponzi-like real estate scheme.” Hayman Capital has taken a short position against the United Development Funding IV. Although UDF has denied any wrong-doing, the FBI raided UDF headquarters in February as part of its investigation into the matter.
Aside from the negative press, there are some big regulatory changes ahead for the sector. A new rule set to go into effect in April will require non-traded REIT funds to report the investment balance—net of fees—on customer statements. Non-traded REITs, for the most part, have a heavy burden of front-end fees of 10 to 12 percent. So if someone invests $1,000, that statement now needs to show that the balance has dropped down to about $900.
“That is a challenge for the financial planners who sell these products,” says Sullivan.
Fundraising slowed down somewhat in the latter half of last year in anticipation of the rule changes as sponsors and financial advisors adopted a new structure called T-shares, which are basically deferred commission products that don’t have as much up-front commission in the initial sale of shares, notes Kevin Gannon, president and managing director at Robert Stanger.
But while the sector may be down, it is not out by any means. The industry will likely see some notable changes ahead as it works to regain its momentum and its credibility.
“I think the industry has gone through an interesting evolution, and we are headed into the third generation for the non-traded REIT industry,” says Sullivan.
The first generation was dominated by firms who proved to be excellent capital raisers. The second generation saw the influx of some savvy real estate players, including Dividend Capital, Griffin Capital and some others, according to Sullivan. The third generation that is just emerging will need to be a combination of good capital raisers and good real estate people, but with fee structures that are much more investor-friendly than in the past, he says.
Private equity firms such as Blackstone, for example, are reportedly looking to expand in the non-traded REIT space.
“I think that is a great example of a terrific capital raiser and a terrific real estate investor who understands that the fee structure going forward needs to be quite different than it has been in the past,” Sullivan says. So the sector could be right at the cusp of the third generation in the evolution of the non-traded REIT space, he adds.
“We expect this will be an avenue that some of the big private equity firms may want to enter to raise money in a retail space, because right now there is about $65 billion in equity in the non-traded space,” says Gannon. “That’s a lot of equity that somebody should want to capture some of that market share.”
Robert Stanger & Co. is predicting that growth beyond 2016 is likely to be at a rate of about 15 percent per year as the market acclimates to the new paradigm in the non-traded REIT space.