Old School Investors Bring New Flavor To Non-Traded REITs
Institutional players are causing non-traded REITs to make a comeback.
Non-traded REITs were once an attractive real estate investment method for small investors — often high net worth individuals — due to their insulation from stock market volatility. While they were particularly appealing following the 2008 financial crisis, fee structures and limited transparency sent the sector into decline, with non-traded REITs posting their lowest fundraising levels in 2017 since 2002.
But thanks to new regulations, the sector has attracted institutional product from the likes of Blackstone Group, Starwood Capital Group and Oaktree Capital in the last year. The rebound in activity has some predicting a non-traded REIT comeback.
“A big institutional player like Blackstone is a nice measure of liquidity,” Robert A. Stanger & Co. Managing Director Kevin Gannon said. “If they perform and educate, that product will dominate. There’s nothing like it with that big institutional sponsorship.”
Blackstone launched its first non-traded REIT in January 2017, and has quickly become a market leader. Under the new rules, investors are charged 3% to 3.5% fees as opposed to the old structure where upfront fees could reach as high as 15%. Investors are also alerted to a REIT’s performance in regular reports, adding increased transparency to the industry.
By April, Blackstone accounted for 41% of all non-traded REIT fundraising for the year. The firm is currently responsible for about 67% of non-traded REIT fundraising, Gannon said.
New Rules, Same Product
Blackstone Real Estate Income Trust has largely benefited from the new fee and regulatory structure. Non-traded REITs were historically chided for their high fees and limited disclosure of risks. In many cases, investors were unaware there was an upfront 15% fee that REITs pocketed — meaning a hypothetical $100 investment was only putting $85 into real estate, Gannon said.
“Equity analysts have laid off criticism because it’s Blackstone, and Blackstone makes a good point with [net asset value],” Gannon said. “The takeaway is there’s a new style of deal with serious institutional sponsorship and active real-time performance measurements. Real time in the real estate world is every month or so.”
The Securities and Exchange Commission put into place a Financial Industry Regulatory Authority rule change in 2016 that gave non-traded REIT investors a better understanding of the cost structure of their investments.
The FINRA 15-02 changes require increased asset valuation transparency, unlike the previous structure that used simple estimations of value per shares during initial non-traded REIT offering periods — meaning actual changes to a principal investment were not explicitly disclosed. The improved financial structure is how players like Blackstone are winning over smaller investors.
“As fees come down, the institutions who normally operate in a low-margin, low-commission environment continue to see this as a positive trend,” Investment Program Association CEO Tony Chereso said. “They are saying, OK, the market is moving in this trajectory, we can bring it to the retail market and take it to the next level.”
Not everyone is ready to sing success quite yet. Only $4.2B in funds were raised in 2017, making it the slowest year for non-traded REITs since 2002. While institutional investors increasingly account for more market share, there have been no full-cycle returns on investments at their low fee structures, while 56 full-cycle returns have occurred at the old structure, according to Atlanta-based Blue Vault Partners Managing Partner Stacy Chitty.
“Fees are down, and there is more money going into the ground at the onset of the program. More of the investor’s dollar is going to the programming,” he said. “It has yet to be determined how warmly the financial advisers will receive the institutional players.”
While it might be too early to gauge their success, institutional players are expected to change how the industry operates. Firms like Blackstone are moving away from the high commission fee structure of legacy sponsors, which Gannon thinks will lead longtime players to shift their business strategies to be more competitive.
“We want a horse race based on the horse and based on performance,” Gannon said. “It’s a good mousetrap, better than the old mousetrap. Everyone just needs to get better educated on the pros and cons.”