Editor's Note: An earlier version of this article incorrectly referred to American Realty Capital (ARC) as American Realty Capital Properties (ARCP).
An accounting scandal that has “handcuffed”one of the largest non-traded REIT sponsors in the country is at least partly to blame for a dip in fundraising activity in 2014.
After a record year of fundraising in 2013, at $19.6 billion, fundraising activity took a step back in 2014 to about $15 billion, according to data from Robert A. Stanger & Co. Inc., a real estate investment banking firm based in Shrewsbury, N.J. It is not too surprising that momentum slowed after a big year of liquidation events in 2013. However, another contributing factor has been that American Realty Capital Properties Inc. (ARCP) and affiliates of its former external manager became embroiled in a highly-publicized accounting scandal.
“That scandal has caused their fundraising to drop precipitously as broker-dealers have suspended the sale of their products,” says Kevin Gannon, president and managing director with Robert A. Stanger & Co.
In October, ARCP revealed that the company made a $23 million accounting error in the first half of the year that was intentionally not corrected. The error created a crisis for ARCP and resulted in the resignation of key executives, including Nicholas Schorsch, who recently resigned as executive chairman of ARCP. Schorsch also resigned from his position on the boards of directors of non-traded REITs managed by Cole Capital, a non-traded REIT sponsor owned by ARCP.
Schorsch is the co-founder of both American Realty Capital Properties (ARCP) Inc. and American Realty Capital (ARC). ARC is a full-service investment advisory firm that sponsors a series of investment programs with an emphasis on publicly registered non-traded real estate offerings. ARCP is a publicly traded REIT focused on investing in single tenant freestanding commercial properties subject to net leases with high credit quality tenants. ARCP also acquires and manages assets on behalf of Cole Capital non-traded REITs. Currently, ARC and ARCP are two separate legal entities. However, up until a year ago ARC served as the external manager for ARC. ARCP officially became a self-managed REIT in January 2014.
In addition, David Kay has stepped down as CEO of ARCP and as a member of the board, while Lisa Beeson resigned as president and COO. The FBI is reportedly conducting a criminal investigation of the company due to the reported accounting errors.
Traditionally, ARC has been the dominant sponsor in the non-traded REIT industry. American Realty Capital’s year-to-date sales as of November exceeded $5.9 billion, accounting for 42 percent of the market share in the non-traded REIT sector, according to Stanger.
“American Realty Capital’s fundraising has certainly taken a hit, which has pulled back on some of the momentum that we have seen in the first nine months of 2014,” says Brian Ruben, head of the national non-traded REIT practice at consulting firm Deloitte. According to Ruben, sales of American Realty Capital’s non-traded REITs declined 58 percent in November compared to October. “So there is certainly impact there,” he says.
House of cards?
The crisis at ARCP could also impact fundraising at Cole Capital, which ranks as one of the top non-traded REIT sponsors as well. The $1.3 billion in sales year-to-date as of November ranked Cole Capital as the second largest non-traded REIT sponsor, with a 9.3 percent market share, which is slightly higher than competitors such as W.P. Carey Inc. and Griffin Capital Corp. ARCP acquired Cole Capital in early 2014.
Combined, ARC and Cole have raised about half of new funds coming into the non-traded REIT sector over the last two years. “If they are handcuffed a little bit, that could pose some challenges, but it also creates opportunities for other sponsors that come into the space to sell product,” says Ruben.
Other sponsors are seeing an uptick in fundraising, which would point to the fact that broker-dealers are still selling the investment product. “We’re hopeful that the situation at American Realty Capital Properties, the publicly traded company that owns the Cole products, will be able to self-contain it,” says Gannon.
However, it will take time for the company to resolve investigations by multiple government agencies. And it also remains to be seen to what extent those investigations will impact the company going forward. “We would expect that it would take a year or more to get to the bottom of the issues, not because of anything additionally wrong, but just caution on the part of regulators,” says Gannon.
Despite challenges facing ARCP, Gannon anticipates a robust year of fundraising for the non-traded REIT sector in 2015. Robert A. Stanger projects that fundraising among non-traded REITs and non-traded business development companies (BDCs) will be in excess of $30 billion in 2015, a jump from the $20 billion in fundraising activity that occurred in 2014.
One reason for the optimism is that one of the largest deals of the year, the $3.4 billion merger of Griffin-American Healthcare REIT II Inc. with NorthStar Realty Finance Corp., closed in December. Griffin investors will receive a payout on that investment, and that capital is expected to come back into the sector in the form of new reinvestments in January and February, notes Gannon.
In addition, there are a number of liquidity events already in the pipeline for 2015.
“I think the momentum that we saw in the first seven calendar months of 2014 slowed down in fourth quarter, but there’s projected to be at least five more liquidity events for 2015 that have been announced,” says Ruben. For example, CNL Lifestyles Properties Inc., Industrial Income Trust, New York REIT and Philips Edison Grocery Center REIT are among companies that are reportedly exploring their options.
“If you go back to the fundamentals of the market, there is a lot of dry powder, a lot of capital on the sidelines waiting to be deployed,” Ruben says.