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Illiquidity Risk in Non-Listed Funds: Evidence from REIT Fund Exits and Redemption Suspensions

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Abstract

Managerial incentives are skewed in non-listed funds under finite horizons. Compensation structures are only indirectly related to shareholder wealth maximization when share prices are unobservable. Liquidity options for investors are limited in the absence of an exchange listing. Using a hand-collected database for public non-listed REITs, an empirical sequence considers the impact of management compensation contracts on equity fundraising and success in capital deployment. Evidence is provided that high asset management fees and high acquisition fees diminish managerial success at generating revenue from invested capital. Successful revenue flows are deterministic factor in the level of distributions paid and the likelihood of achieving a fund exit. Closing the gate on share redemption plans is synchronized with the slowdown in new equity flows. Retail investors are insensitive to maligned compensation structures that heighten illiquidity risk, even when observable in the prospectus.

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Notes

  1. “Illiquidity risk is added” in the sense that these securities do not trade on an organized stock exchange, redemption plans are limited and require time to initiate (some have never opened to investors) then may become maxed out, repriced, suspended or cancelled, and only a few funds have actually accomplished fund exits through exchange listing, merger/acquisition, asset divestiture, or bankruptcy.

  2. For an example of the common depiction, the Investment Program Association (IPA) describes public non-listed REITs on their website as follows: “Because non-traded REITs have a share price that doesn’t fluctuate on a daily basis, they are generally considered less volatile than their publicly-traded counterparts. Non-traded REIT investors typically sacrifice ready liquidity in exchange for higher yields…”

    [From: http://www.ipa.com/industry-faq. Accessed May 28, 2012]

    In addition, a recent FINRA investor alert (August 15, 2012) states that “…the periodic distributions that help make these products so appealing can, in some cases, be heavily subsidized by borrowed funds and include a return of investor principal.”

    [From: http://www.finra.org/Investors/ProtectYourself/InvestorAlerts/REITS/P124232. Accessed January 31, 2013]

  3. 35 % is based on the author’s calculation using growth in cumulative proceeds from common stock accounts collected from 10-K filings by all identified public non-listed REITs. Accumulation begins in 1994 and annual percentage growth is from 2001 to 2011. $88.3 billion is measured in book values from 10-K filings collected from 67 funds identified to exist as public non-listed REITs at the end of 2011.

  4. The exceptions include several Apple REIT offerings at $11 per share, Clarion Properties Trust at $10.31, Cornerstone products at $8, and NorthEnd Income Properties Trust at $10.25 per share.

  5. These typical values are based on the sample means from the initial S-11 filings for the 79 funds considered in this study.

  6. 56 of the 79 funds intend to declare distributions on a monthly basis; the remainder intend to declare “quarterly”, “monthly or quarterly”, or “periodically”.

  7. The exceptions to organizing in Maryland include the Apple REITs, G REIT and T REIT which organized in Virginia.

  8. A common redemption plan varies the repurchase price according to the length of time the security is held, beginning at $9 after the first year, $9.25 after the second, to become $9.50 after the third year. Restrictions include the requirement to submit at least 25 % of shares held by the individual investor and that total redemption requests funded cannot exceed 5 % of shares outstanding.

  9. Six years is the average lower bound in the sample, 8 years is the average for the upper bound. The most common intended liquidity target mentioned is the NASDAQ listing.

  10. Six funds have not yet had their registrations declared effective by the SEC as of November 2011, including CM REIT, Inc., Cole Real Estate Income Strategy Daily NAV, Inc., Cole Credit Property Trust IV, Inc., Income Property Trust of Americas, Inc., NorthStar HealthCare Trust, Inc., and Prime Realty Income Trust. Two funds have withdrawn their registration, including ARC—Northcliffe Income Properties, Inc. and NorthEnd Income Properties Trust, Inc. Two funds did not originally organize as a public non-listed REIT, including Cole Credit Property Trust (no S-11 filings or prospectus) and Prime Group Realty Trust (originally exchange-listed).

  11. Corporate Property Associates 10, Inc. entered into a merger agreement with Carey Institutional Properties, Inc. on December 14, 2001. Apple Suites, Inc. entered into a merger with Apple Hospitality Two, Inc. on October 24, 2002. Carey Institutional Properties, Inc. entered into a merger with Corporate Property Associates 15, Inc. on August 25, 2004. Corporate Property Associates 12, Inc. entered into a merger with Corporate Property Associates 14, Inc. on November 30, 2006. Corporate Property Associates 14, Inc. entered into a merger with Corporate Property Associates 16 Global, Inc. on December 13, 2010.

  12. CNL Restaurant Properties, Inc. entered into a merger with U.S. Restaurant Properties (NYSE:USV) on February 24, 2005. CNL Retirement Properties, Inc. entered into a merger with Ocean Acquisition 1, Inc., a wholly owned subsidiary of Health Care Property Investors, Inc. (NYSE:HCP) on September 26, 2006. Inland Retail Real Estate Trust, Inc. entered into a merger with Developers Diversified Realty Corporation (NYSE:DDR) on February 22, 2007. Corporate Property Associates 15, Inc. entered into a merger with W.P. Carey & Co., LLC (NYSE:WPC) on February 17, 2012.

  13. CNL Hotels & Resorts, Inc. entered into a merger with MS Resort Acquisition LLC, an affiliate of Morgan Stanley Real Estate Fund V, U.S., L.P. on April 10, 2007. Apple Hospitality Two, Inc. entered into a merger with Lion ES Hotels, L.P. on May 18, 2007. Apple Hospitality Five, Inc. entered into a merger with Inland American Real Estate Trust, Inc. on September 17, 2007.

  14. The shareholders of T REIT, Inc. approved a plan of liquidation involving asset sales in the private market on July 27, 2005. The shareholders of G REIT, Inc. approved a plan of liquidation involving asset sales in the private market on February 27, 2006.

  15. On April 29, 2011, a petition for involuntary Chapter 11 bankruptcy was filed against Desert Capital REIT, Inc. by a group of lenders.

  16. Inland Real Estate Corp. became exchange-listed (NYSE:IRC) and shares began trading on June 9, 2004. DCT Industrial Trust, Inc. became exchange-listed (NYSE:DCT) and shares began trading on December 13, 2006. Piedmont Office Realty Trust, Inc. became exchange-listed (NYSE:PDM) and shares began trading on February 10, 2010. Whitestone REIT became exchange-listed (NYSE:WSR) and shares began trading on August 26, 2010. American Realty Capital Trust, Inc. became exchange-listed (NASDAQ:ARCT) and shares began trading on March 1, 2012.

  17. Cash flow from operations is used in the numerator of Operating Cash Flow. This is an analog to the profit margin as a component of return on assets and return on equity, which has net income in the numerator. Net income is not considered since it has only limited meaning for real estate trusts due to significant non-cash expense items including amortization and depreciation for real assets.

  18. The near uniform set of organizational characteristics includes the $10 offering share price to retail investors, investor requirements (e.g., minimum net worth of $250,000), UPREIT structure, external management, incorporation in the State of Maryland and corresponding anti-takeover provisions including staggered elections, expansive board, preferred stock plan (i.e., poison pills), and significant fees to the advisor in the event of a takeover.

  19. Relatively unique characteristics include an initial endowment of convertible preferred shares or warrants held by the sponsor, or the minimum investor purchase requirement of $10,000 where the standard is $2,500.

  20. Information available by the end of the first year generally claims the least predictive behavior since a number of funds have yet to break escrow by this point in time. Absent consideration for the initial year, fund-years two and three allow the maximum number of observations, since observations for the proportional hazard model is based on the number of funds with available data at the relative point in fund-life, rather than fund-years of data available.

  21. Adjusting for the log-linear structure, e2.211 equals 9.12.

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Authors and Affiliations

  1. Department of Real Estate, J. Mack Robinson College of Business, Georgia State University, 35 Broad Street, Suite 1408, Atlanta, GA, 30303, USA

    Jonathan A. Wiley

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Correspondence to Jonathan A. Wiley.

Appendices

Appendix A

Table 10 List of public non-listed REITs
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Appendix B

Table 11 Correlation matrices
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Wiley, J.A. Illiquidity Risk in Non-Listed Funds: Evidence from REIT Fund Exits and Redemption Suspensions. J Real Estate Finan Econ 49, 205–236 (2014). https://doi.org/10.1007/s11146-013-9422-3

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