The Journal of Real Estate Finance and Economics

, Volume 49, Issue 2, pp 205–236

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

Authors

    • Department of Real Estate, J. Mack Robinson College of BusinessGeorgia State University
Article

DOI: 10.1007/s11146-013-9422-3

Cite this article as:
Wiley, J.A. J Real Estate Finan Econ (2014) 49: 205. doi:10.1007/s11146-013-9422-3
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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.

Keywords

Managerial incentivesAgency problemsUnlistedLiquidation

JEL Classification

G11G24G32G33

Introduction

Illiquidity risk is a central issue for investors in non-listed funds—a sector that includes hedge funds, venture capital (VC) and buyout funds. Two major concerns include (1) the threat of redemption suspensions for funds that offer share redemption plans, and (2) uncertainty regarding the timing and nature of fund exit. Overall, capital raised from new equity investors at private equity and non-listed public funds has experienced tremendous growth in recent years with private equity funds currently managing more than an estimated $1 trillion in capital. Yet, only limited information is available for illiquidity risk due primarily to data constraints.

This study utilizes a hand-collected sample of data from the public non-listed real estate investment trust (REIT) sector where (1) redemption suspensions and (2) fund exits are ex post observable. The data is analyzed to identify several key factors which contribute to either form of illiquidity risk. Common characteristics among public non-listed REITs support an approach that evaluates the outcome for shareholders through conditions that are observable at fund initiation. The empirical sequence and findings introduced for public non-listed REITs are important because they offer a structure for evaluating illiquidity risk in the broader sectors of private equity and non-listed asset management funds where traditional performance metrics are unavailable, including during the initial subscription period.

Hedge funds commonly offer share redemption plans to provide some liquidity for their investors. Certain redemption provisions enhance managerial discretion, such as the length of the initial lockup period, the amount of notice required, and the interval between redemption periods. Agarwal et al. (2009) find that hedge fund redemption plans which offer greater managerial discretion are associated with superior fund performance. Aragon (2007) argues that hedge fund share restrictions enable managers to achieve excess returns by investing in less liquid assets. The analog in the mutual fund sector is high exit fees on open-end mutual funds which create a structure similar to the closed-end mutual fund. High exit fees discourage investor redemptions and enable managers to more effectively deploy capital (Chordia 1996; Nanda et al. 2000).

While these findings provide some justification for share restrictions, the risk of redemption suspensions in non-listed funds remains relatively unexplored. Suspensions by hedge funds have recently increased in incidence, particularly during the 2008 financial crisis (Kumiega et al. 2010). The suspension of a share redemption plan effectively converts an open-end fund to a closed-end fund. Berk and Green (2004) find that underperformance by mutual funds leads to equity outflows and increases liquidation risk. The option to suspend redemptions brings a sudden end to fund outflows. When the suspension option is available to non-listed funds, it is expected that equity subscription volume and fund performance should contribute to the risk of redemption suspensions.

Fee structures are known to influence fund performance. High brokerage commissions and front-end loads are the cause of low mutual fund flows (Barber et al. 2005). Front-end loads on mutual funds are associated with underperformance relative to no-load funds (Carhart 1997). Some ongoing fees are independent of performance, such as asset management fees, and have no impact on hedge fund returns. On the other hand, incentive fees are positively related to higher returns (Liang 1999). High-water mark provisions create an incentive to increase risk-taking behavior as the fund value approaches the threshold (Goetzmann et al. 2003). When managers have greater discretion in reporting returns, there is an incentive to smooth returns in order to avoid capital outflows and sustain compensation that is tied to fund size (Cassar and Gerakos 2011). Thus, managerial incentives are endogenous. The compensation contract affects fund flows and performance, which subsequently contribute to the risk of redemption suspensions.

If the gate is closed on redemptions, investors have little choice but to wait until managers execute a liquidation strategy in order to receive the complete return on their invested capital. Possible liquidation options include an exchange listing, acquisition by another fund, divestiture of individual assets in the private market, or bankruptcy proceedings. Metrick and Yasuda (2010) report that 62.9 % of VC backed-companies actually exited within 5 years of the initial VC investment. Of those exits, 20.5 % had an initial public offering, 38.3 % were acquired, and the remainder went out-of-business. IPOs tend to be the most profitable exit option with gross value multiples at least double for 80.7 % of IPOs. By comparison, 38 % of acquisition exits have multiples less than one (i.e., lose money for investors). Gottschalg et al. (2003) point out that the decision to liquidate a private equity fund should be endogenous and is likely driven by the success of investments. In the model of Aghion et al. (2004), exit timing in VC financing should be influenced by managerial incentives, including the manager’s own liquidity needs and borrowing constraints. For the finite-horizon fund, option-like payoff structures cause managers to adjust allocations over time toward increasingly riskier assets (Ljungqvist et al. 2008) and investments with shorter horizons (Kandel et al. 2011). In VC funds, the percentage of successful investment exited via IPO or acquisition is often used as a proxy for successful performance (Hochberg et al. 2007; Phalippou and Gottschalg 2009). Phalippou and Gottschalg (2006) estimate private equity exit success as a continuous variable using fund size, type, focus and sequence as proposed determinants.

In the case of public non-listed REITs—which fit into the broader category of asset management intermediaries – liquidation is defined for the fund in entirety. The comprehensive nature of liquidation is in contrast to the percentage exit rate used in private equity, which measures success in divesting individual investments at a given time in the fund life. A descriptive overview of the public non-listed REIT sector is provided by Corgel and Gibson (2008) for U.S. funds, and by Brounen et al. (2007) for European funds. Due to tax regulation, public non-listed REITs primarily invest in substitutable assets that generate income in the form of rents net of property expenses. A much larger degree of heterogeneity exists among the assets selected and sources of income for VC and buyout funds. The long economic life and functioning secondary market for the underlying assets, combined with the finite-horizon and related income sourcing, produces similar life cycles for the typical public non-listed REIT. Capital is raised and deployed early in the fund life. High transaction costs limit the opportunity to adjust allocations toward riskier assets when the investment horizon nears. The discrete measure for liquidation and structure fund cycle introduce a consistent but nontrivial environment to examine illiquidity risks for non-listed funds—with $32 billion in subscriptions from new equity investors during 2007–2011.

Management compensation tables include both incentives and disincentives for fund exit, such as asset management fees, acquisition fees, disposition fees, shares in distributions, and subordinate participation. Asset management fees and distribution sharing provide incentives to use leverage and maximize fund size, but a disincentive to successfully liquidate the fund. Acquisition fees combine with broker commissions to reduce the effective amount of funds available for investment per dollar in equity contributed. Disposition fees and repeat acquisition fees create incentives to churn assets under management, rather than incentives for fund closure. Each contract provision listed above offers an incentive for survival. The primary gain to managers from fund exit is through subordinate participation—which is restrained by contingencies to exceed nominal hurdle rates.

A database for the complete public non-listed REIT sector is hand-collected from filings in the SEC Edgar database from 1994 thru 2011, including 79 funds and 425 fund-years. A set of independent variables from the compensation contract is developed which considers the impact of selling commissions, asset management and acquisition fees, and liquidity horizon targets. The empirical estimation is sequential, beginning with the ability to raise common equity and generate revenue from invested assets as a function of the compensation contract. The ability to generate revenue from invested assets and growth in common equity are included in a set of variables for the underlying fundamentals, along with the ability to convert revenue to operating cash flow, the use of leverage and dividend reinvestment enrollments. The set of fundamentals are then examined for their impact on distribution levels and distributions relative to operating cash flow, redemption plan openings, constrained redemptions, and likelihood of achieving a comprehensive liquidity event.

The remainder of this study is organized as follows. Background & Data: Public Non-listed REITs section provides Background based on the sample of data collected, relating the characteristics of public non-listed REITs to those identified for similar investment products. Specification section outlines a Specification for the empirical procedures carried out. Section IV discusses the Empirical Results, and Section V offers Concluding Remarks based on the findings of this research.

Background & Data: Public Non-listed REITs

This section provides an overview for the public non-listed REIT sector, where the descriptive background information in more extensive than usual. The purpose is to aid the reader in understanding public non-listed REITs since there is only limited information available in the extant literature. Corgel et al. (1995), Zietz et al. (2003), and Feng et al. (2011) each provide an overview for exchange-listed REITs.

Public non-listed REITs are similar to exchange-listed REITs in that they are subject to the same tax regulation which establishes minimum limits for assets invested in real estate, income derived from real estate, dividend payouts, and maximum limits for shareholdings and income from taxable subsidiaries. Public non-listed REITs are also subject to SEC, NASD and NASAA requirements. Key differences from exchange-listed REITs include the use of “blind pool” offerings, fixed share prices, distribution through broker-dealer channels, finite-life structure, and the higher fee structures imposed by non-listed REITs. Most relevant to this study, illiquidity risk is added to public non-listed REITs introducing uncertainty for redemption suspensions and fund exits.1

Public non-listed REITs are investment products sold primarily to retail investors by investment advisors (Corgel and Gibson 2008). They are believed to deliver superior dividend yields and stabilize portfolios with limited share price fluctuations.2 Responding to these claims, the cumulative amount of common equity raised by the industry has grown by an average of 35 % per year from 2001 thru 2011 and includes $88.3 billion in assets under management by the end of 2011.3 Figure 1 illustrates the recent ability of the industry to generate common equity, averaging roughly $8 billion per year from 2006 thru 2011, relative to exchange-listed REITs which raise just $1.85 billion per year through IPOs during the same period. Of course, IPOs on organized exchanges have become much less common in general during this period. The common equity raise falls short of the $18 billion in average funds raised by exchange-listed REITs through SEOs since 2006, which has skyrocketed recently.
https://static-content.springer.com/image/art%3A10.1007%2Fs11146-013-9422-3/MediaObjects/11146_2013_9422_Fig1_HTML.gif
Fig. 1

Common Equity Raised: Public Non-listed vs. Exchange-listed REITs (in Millions$). Notes: This figure depicts the aggregate common equity raised per year by public non-listed REITs (in black) compared to the same by exchange-listed REITs (in grey), during the period 1994–2011. The data for public non-listed REITs is generated from data hand-collected for this study. The reported value measures the sum of Proceeds from Common Stock collected from the Consolidated Statement of Cash Flows—Cash Flows from Financing Activities. The data for exchange-listed REITs is collected from NAREIT—Complete History of Initial Public Offerings and Complete History of Seasoned Equity Offerings.

The typical public non-listed REIT is initially distributed through a continuous offering process at a fixed share price, often $10 per share.4 Sizeable front-end fees limit the amount available to invest in real estate to $8.59 per average share after subtracting 6.5 % in average selling commissions to the broker, 2.5 % in average fees to the dealer-manager, 2 % in average acquisition fees and 0.5 % in acquisition expenses to the advisor, recovering 2.3 % in organizational and offering expenses for the sponsor, and setting aside 0.3 % in working capital reserves.5 Investment is commonly into a “blind pool” offering of an externally-managed fund with no assets or revenue existing. The expressed intent is to invest in income-producing real estate, declare distributions to shareholders on a monthly basis and attempt to later qualify as a REIT.6 Disclosures are made to the effect that significant conflicts of interest exist for the external advisor who manages other real estate funds. The organization is in Maryland, an investment trust friendly state.7 The organizing documents include significant anti-takeover provisions embedded in the corporate governance including staggered elections, expansive boards, preferred stock plans as poison pills, and sizeable fees to the advisor in the event of internalization including for liquidation and takeover. A redemption plan is outlined which allows investors the opportunity to redeem their shares at $9.50 per share, subject to certain limitations including adequate subscription to the dividend reinvestment plan.8 Disclosure is made that the redemption plan may never become effective and could be cancelled or suspended after opening. A liquidity event target is defined by the intention to list on the NASDAQ within 6 to 8 years after commencing the offering, although the liquidity event may take longer than expected and may not involve an exchange listing.9

The data used in this study is from each 423(b)(3) prospectus and 10-K annual filing during 1994 thru 2011, hand-collected from the SEC Edgar database for all publicly-registered, non-exchange listed REITs. In total, there are 89 funds of which ten are deleted because they had not yet been declared effective registrations by the SEC, have withdrawn their registrations, or did not initially organize as a public non-listed REIT.10 The complete list of the 89 public non-listed REITs included in the sample is provided in Appendix A.

The sample includes all U.S. public non-listed REITs with information available during the observation period. Considering U.S. funds only introduces possible selection bias, as international real estate equity performance can be unrelated to U.S. funds (Worzala and Sirmans 2003). International capital markets may be less efficient in their ability incorporate fees and expenses into fund valuations. Otten and Bams (2002) find that European mutual funds demonstrate positive alphas net of fees, in contrast to results for the U.S. where expenses entirely offset any outperformance by mutual funds (Carhart 1997).

An account for the number of funds in the sample according to fund age and liquidation status is provided in Table 1. Of the 79 funds considered in this study, 20 have initiated liquidation plans as of March 2012. The most common method of liquidation is by merger or acquisition, as in the case of 12 funds. Five of the 12 mergers are with an affiliated public non-listed REIT.11 Four mergers involve mergers with public exchange-listed funds.12 Three mergers are with a non-affiliate, either limited partnership or another public non-listed REIT.13 Two of the 20 total liquidations involve the divestiture of assets individually in the respective commercial real estate markets over a lengthy period of time.14 One fund is involved in bankruptcy proceedings.15 The five remaining became exchange-listed.16 For the 59 funds that continue as public non-listed REITs and have not initiated a plan of liquidation by the end of 2011, the average fund remaining in the industry is young with fewer than four annual 10-K filings available.
Table 1

Number of funds and liquidations, by fund-year

Fund-year

Cumulative

Last available

Liquidity event

Acquired

Listing

Divestiture

Bankruptcy

1

79

7

     

2

72

13

     

3

59

12

2

1

 

1

 

4

47

6

3

1

2

  

5

41

5

1

  

1

 

6

36

6

2

1

1

  

7

30

10

1

   

1

8

20

4

2

2

   

9

16

6

1

1

   

10

10

3

2

1

1

  

11

7

3

3

3

   

12

4

2

2

1

1

  

13

2

0

     

14

2

2

1

1

   

This table describes the count of public non-listed REITs with data available at each fund year. The first column reports the fund-year, which equals the total number of 10-K filings available from the SEC. Cumulative reports the total number of funds where the quantity of 10-K filings available is greater than or equal to the value for Fund-year. Last available reports the number of funds where the volume of 10-K filings available is exactly equal to the value for Fund-year. Liquidity event reports the number of funds from the Last available subset for each Fund-year that drop out of the sample due to a liquidity event that occurs prior to March 2012. The remaining columns detail the method of liquidation during each Fund-year. Acquired is for funds that were liquidated through a merger or acquisition of another public fund. Listing is for funds that were exchange-listed on the NYSE or Nasdaq. Divestiture is for funds that were liquidated through individual asset sales in the respective commercial real estate markets. Bankruptcy is for funds dissolved through the bankruptcy process

With few exceptions, the typical public non-listed REIT is initially distributed as a blind pool, without assets under management at the time of the offering. Instead of the opportunity to observe prior performance, investors subscribe based on the information revealed in the initial filings alone, including management résumés, investment strategies, and incentives from the compensation structure outlined in the S-11 filings with the SEC. As a result, there is an emphasis in this study on the managerial incentives to identify whether information signaled by managers in the prospectus alone is related to illiquidity risk for the fund, including the redemption suspensions and comprehensive liquidity events.

Descriptive statistics for the public non-listed REITs are presented in Table 2. Panel A introduces a selection of variables related to the initial compensation contract, which are collected from each prospectus. The sector persists as one of the few high commission products remaining for broker-dealers who distribute alternative investments. In Gil-Bazo and Ruiz-Verdú (2009), the average load in the mutual fund industry is 3.08 %. For public non-listed REITs, the average commission rate paid to the independent broker-dealer on the front-end is 6.8 %. 83.5 % of funds offer a selling commission that is greater than 6 % for new equity subscriptions.
Table 2

Summary statistics

Panel A. Summary of Contract Design

    

79 Funds

Prospectus

Mean

(Std Dev)

Min

Max

Variable

Percent of Sample

 Commission Rate

6.8 %

(1.1 %)

0.0 %

8.0 %

High Commissions

83.5 %

 Asset Mgmt Fees

0.8 %

(0.4 %)

0.1 %

2.0 %

High Asset Mgmt Fees

43.0 %

 Acquisition Fees

2.0 %

(0.9 %)

0.5 %

4.5 %

High Acquisition Fees

7.6 %

 Liquidity Horizon

6.5

(2.7)

2

14

Long Horizon

39.2 %

Panel B. Summary of Fund-years

      

Variable/Fund-year:

1

2

3

4

5

6

7

 Common Equity Raised

$46.2 ($116.8)

$193.0 ($333.6)

$252.5 ($321.7)

$354.7 ($484.9)

$198.8 ($329.5)

$166.6 ($452.4)

$106.9 ($239.1)

 Common Equity Growth

49.1 % (180.6 %)

19.1 % (17.0 %)

7.4 % (4.9 %)

4.1 % (3.6 %)

2.1 % (4.2 %)

1.2 % (3.1 %)

1.2 % (2.9 %)

 Operating Efficiency

2.0 % (3.4 %)

5.4 % (5.1 %)

8.9 % (6.8 %)

10.1 % (6.7 %)

11.4 % (9.0 %)

10.9 % (7.8 %)

10.9 % (5.1 %)

 Operating Cash Flow

−64.345 (394.43)

−2.652 (21.42)

0.290 (0.76)

0.413 (0.45)

0.496 (0.67)

0.283 (0.34)

0.320 (0.22)

 Leverage Ratio

0.411 (0.34)

0.398 (0.25)

0.414 (0.21)

0.397 (0.19)

0.436 (0.18)

0.479 (0.17)

0.477 (0.19)

 Distribution Rate

$0.30 ($0.36)

$0.62 ($0.36)

$0.75 ($0.80)

$0.67 ($0.21)

$0.67 ($0.24)

$0.59 ($0.31)

$0.63 ($0.40)

 Dividend Reinvestments

9.3 % (25.1 %)

27.8 % (20.0 %)

34.2 % (20.9 %)

36.1 % (21.1 %)

35.3 % (24.5 %)

32.3 % (24.7 %)

29.4 % (23.5 %)

 Sustainable Distributions

22.8 %

25.0 %

27.1 %

36.2 %

29.3 %

44.4 %

50.0 %

 Effective Redemptions

5.0 %

37.5 %

79.7 %

85.1 %

63.4 %

41.7 %

40.0 %

 Constrained Redemptions

0.0 %

0.0 %

0.0 %

4.3 %

24.4 %

44.4 %

43.3 %

 At Limit

0.0 %

0.0 %

0.0 %

4.3 %

7.3 %

13.9 %

6.7 %

 Suspended

0.0 %

0.0 %

0.0 %

0.0 %

17.1 %

30.6 %

26.7 %

 Repriced

0.0 %

0.0 %

0.0 %

0.0 %

0.0 %

0.0 %

10.0 %

 Cancelled for Liquidation

0.0 %

0.0 %

0.0 %

2.1 %

4.9 %

8.3 %

13.3 %

Number of Funds

79

72

59

47

41

36

30

This table provides summary statistics for the sample of public non-listed REITs. Panel A covers selected data collected from the prospectus for each fund, including the mean, standard deviation, minimum and maximum values along with the respective indicator variable and the percentage of the sample identified by that variable. Commission Rate is the commission paid to broker-dealers as a percent of gross equity raised. High Commissions equals one if the Commission Rate is greater than 6 %, zero otherwise. Asset Mgmt Fees are asset management fees paid to the advisor as a percentage of assets under management. High Asset Mgmt Fees equals one if Asset Mgmt Fees are 1 % or greater, zero otherwise. Acquisitions Fees are the fees paid to management for purchasing each property as a percentage of the gross purchase price. High Acquisition Fees equals one if Acquisition Fees are greater than 3 %, zero otherwise. Min Liquidity Horizon reports the minimum value from the reported range for the liquidity event target in years. Long Horizon equals one if the Min Liquidity Horizon is greater than 7 years, zero otherwise.

Panel B summarizes data collected from the annual 10-K filings for fund-years two thru seven. Panel B reports the sample mean (and standard deviation in parentheses) for each fund-year. Common Equity Raised is the proceeds from common stock, in millions. Common Equity Growth equals Common Equity Raised divided by the weighted average number of shares outstanding. Operating Efficiency equals total revenue divided by total assets. Operating Cash Flow equals cash flow from operations divided by total revenue. Leverage Ratio equals total liabilities divided by total assets. Distribution Rate is the total annual dividends declared per share. Dividend Reinvestments equals the percentage of distributions reinvested in common equity through a distribution reinvestment plan. Sustainable Distribution equals one if the Distribution Rate multiplied by the weighted average number of shares outstanding is greater than cash flow from operations. Effective Redemptions equals one if the fund actually repurchased shares during the year and the redemption plan was not constrained, zero otherwise. Constrained Redemptions equals the sum of At Limit, Suspended and Repriced. At Limit equals one during fund-years where the redemption plan receives more requests than can be filled based on pre-established limits, zero otherwise. Suspended equals one for the fund during years when the redemption plan has been suspended or cancelled after previously being open, zero otherwise. Repriced equals one for the fund during years when redemptions are offered, but at a discount of at least 10 % from the redemption price mentioned in the prospectus, zero otherwise. Cancelled for Liquidation equals one when the redemption plan is suspended or cancelled in accordance with the plan of liquidation, zero otherwise.

Asset management fees average 0.8 % of total assets under management for public non-listed REITs, and 43 % advertise asset management fees of 1 % or higher. To compare with the mutual fund sector, asset management fees within the expense ratio average 0.24 % (Adams et al. 2012). However, real estate mutual funds tend to charge much higher management fees at 0.79 % on average (Philpot and Peterson 2006), which is nearly identical to management fees levied by the average public non-listed REIT.

Acquisitions fees average 2 % of the gross purchase price for every new property acquired, and 7.6 % of funds allow acquisitions fees in excess of 3 %. Ooi (2009) reports acquisition fees for exchange-listed REITs in Singapore to be almost uniformly 1 %, with one exception at 1.5 %. Due to the lack of liquidity for public non-listed REITs, each fund is structured as a finite-horizon fund with the target liquidity horizon typically specified as a range of years. The average lower bound to the range is six and a half years, although it varies from two to 14 years with 39.2 % of funds targeting the earliest liquidity event no sooner than 8 years from the initial offering. In Ambrose and Linneman (2001), just five out of 139 exchange-listed REITs are organized with a finite life.

Panel B in Table 2 reports underlying fundamentals for the funds during the first 7 years of existence. This sample horizon relates to the empirical approach where estimations have observations equal to the number of funds in the sample and in other cases the observations are in fund-years. The total number of fund-years available for a balanced panel, which is one that includes only funds that survive the sample horizon, is maximized at fund-year six with 216 fund-years of observations available. Estimations for balanced panels thru age five (205 fund-years) and seven (210 fund-years) are also provided. The selection of variables for fund fundamentals is based on relative metrics for each fund’s continued access to common equity (Common Equity Growth), revenue generated from funds invested (Operating Efficiency), cash generated from revenue (Operating Cash Flow), the use of debt in the capital structure (Leverage Ratio), returns to investors (Distribution Rate), and the percentage of non-cash distributions (Distributions Reinvested).

Considering the summary statistics in Panel B of Table 2, it can be seen that the amount of common equity raised peaks in year four at $354.7 million for the average fund. The variance in raising common equity also peaks during year four. Unlike the traditional IPO process for exchange-listed funds, public non-listed REITs are distributed through a continuous offering process, typically at $10 per share. The continuous offering can last up to 3 years, although many funds introduce follow-on offerings almost immediately after the initial offering accomplishes the maximum subscription, extending the continuous offering for an additional multi-year period. Corgel and Gibson (2008) provide one of the only academic articles on public non-listed REITs and demonstrate with a theoretical model that the fixed share price and continuous offering process for non-listed REITs allows follow-on investors the opportunity to observe performance before deciding to subscribe. With an IPO, an increase in investment by follow-on shareholders benefits early equity investors in the form of capital gains. However, front-end loads are so high with non-listed REITs that this potential benefit is likely captured by the broker-dealers selling shares and earning commissions. Common Equity Raised reported in Table 2 combines the proceeds from the initial offering with all subsequent offerings.

Operating Efficiency begins at a relatively low value, 2 % in year 1, and subsequently stabilizes above 10 % by year four and following. Total revenue is in the numerator of the Operating Efficiency ratio, and total assets in the denominator, measured in book value since reliable market values are unavailable. For a young fund, historic cost can serve as a reasonable approximation to market value. In this context, Operating Efficiency (also called the asset turnover ratio by non-real estate funds) measures the success of managers at generating revenue from funds invested, which is a fundamental component for return on assets and return on equity. That revenue is leveraged before converting to cash flow, with an average Leverage Ratio around 0.43 during the observation period. Operating Cash Flow is scaled by total revenue, reporting the percentage of revenue that becomes available as cash flow after operating expenses (excluding non-cash expenses).17 To illustrate, by fund-year four, the average fund is generating $0.101 per $1 invested (Operating Efficiency) and 41.3 % of that revenue becomes operating cash flow, or $0.417 in operating cash flow per $10 investment.

Distributions are relatively high given the level of operating cash flow, with annual declarations after year one fluctuating between $0.59 and $0.75 per share, after adjusting for $10 initial share value. The highest level of Distributions Rate is in year 3. Roughly one-third of the distributions declared are reinvested after the first year, typically at $9.50 per share as stock dividends, which does not require a cash disbursement. The high distributions announced by the public non-listed REITs are often not sourced by operating cash flow exclusively, but require leverage to fund or function as a return of capital. Just 25 % of public non-listed REITs have cash flow from operations that is greater than the level of distributions declared by fund-year two (i.e., Sustainable Distributions). Even by year seven, only one out of every two funds declares distributions that are greater than per share cash flow from operations.

In the absence of a plan for liquidation and a reliable secondary market for the shares, public non-listed REITs almost uniformly announce a redemption plan in the initial prospectus where shares can be repurchased periodically on a first-come, first-serve basis. Disclosures are commonly provided to the effect that the redemption plan may not initiate until the distribution reinvestment plan proves adequately subscribed. Limits to redemption include 5 % of outstanding shares, and the redemption plan may be canceled or suspended after it initiates. These disclosures are fateful. By the year-end 2011, 25 of the 79 public non-listed REITs had never opened the redemption program to all investors. The average time to initiation is 1 year from the date of the initial offering, yet some funds delay until the second or third year to implement. Of the 54 redemption programs that did become effective at some point, 25 programs ultimately became Constrained Redemptions at some point by restricting the program to exceptional circumstances (e.g., death, qualifying disability), reaching the program limit with a backlog of unfilled redemption requests, significantly reducing the price on the redemption program, or suspending/cancelling the program altogether. The frequency of Constrained Redemptions increases in years five thru seven, as shown in Table 2. The accounting for Constrained Redemptions does not include redemption programs that were cancelled or suspended in accordance with an approved plan of liquidation. By year-end 2011, just 29 of the 79 public non-listed REITs had actually opened a redemption program and remain with an unconstrained record of redemptions.

Specification

The empirical approach follows a sequence for the non-listed fund development beginning with the impact of compensation contract variables. The role of managerial incentives in illiquidity risk is not considered directly, due to potential endogeneity with other factors that influence fund performance. Instead, a set of contract variables is introduced as determinants for the ability to raise common equity and success at generating revenue from investing (named the Operating Efficiency ratio). The underlying fund fundamentals are then related to the likelihood that a redemption plan will initiate and its risk of subsequently becoming constrained, as well as the level of distributions paid to shareholders and their sustainability. Finally, the underlying fundamentals are evaluated as determinants of the likelihood that a fund exit will occur and its proximity.

At origination is the compensation contract and offering, which determine the quantity of shares to be offered and the share price as well as terms for distribution reinvestments, board size and independence, director compensation, and corporate governance. A number of characteristics are relatively uniform for public non-listed REITs.18 Others are adopted by very few funds.19 Given the relatively small industry size, an evaluation of differences stemming from attributes that are nearly identical to all funds in the industry is impractical from an empirical standpoint. The focus on compensation contract variables is narrowed to a set of metrics that are reported consistently by all funds and characterized by some intra-industry variance. The contract variables include the selling commission offered to broker-dealers, the asset management and acquisition fees, and the liquidity event horizon. To consider whether selection of elevated fees is relevant, each of the contract variables is measured as an indicator variable selecting funds above a specific threshold. The thresholds are defined greater than 6 % for High Commissions, at least 1 % for High Asset Mgmt Fees, greater than 3 % for High Acquisition Fees, and no sooner than 8 years for Long Horizon. Shown in Appendix B, the joint correlations among this set of contract design variables is insignificant from zero for funds that survive 5, 6 and 7 years.

The contract variables listed above are converted from continuous to discrete in the empirical analysis in order to avoid high correlations among regressors. This adjustment is performed only in the estimations for determinants of common equity inflows and operating efficiency, which are not the central focus of the study. Estimations for the likelihood of redemption suspensions and fund exit include only continuous variables (with the exception of fixed effects). The breakpoints used to define these dummy variables result in a consistent set of contract variables which have low correlations among the set, but the specific breakpoints are arbitrary in the sense that they are not unique since other breakpoints would result in similarly low correlations among the set of regressors. The main results in estimations using dummy variables include high commissions boost the common equity raise (Table 3), and aggressive asset management and acquisition fees reduce operating efficiency (Table 4). Alternative results using the continuous version of the measures confirm the robustness of these results.
Table 3

Raising common equity

Sample horizon:

5 Fund-years

6 Fund-years

7 Fund-years

Variable

Coefficient

(Χ2)

Coefficient

(Χ2)

Coefficient

(Χ2)

 Constant

9.755

**

(5.9)

13.622

***

(8.3)

2.975

 

(0.7)

 High Commissions

2.211

**

(4.6)

2.811

***

(6.7)

3.041

**

(6.5)

 High Asset Mgmt Fees

−0.656

 

(0.6)

−0.849

 

(0.9)

−1.790

*

(2.8)

 High Acquisition Fees

−0.318

 

(0.1)

−0.017

 

(0.0)

−0.431

 

(0.1)

 Long Horizon

−0.221

 

(0.1)

−0.157

 

(0.0)

−0.742

 

(0.6)

Fund-age controls:

Included

Included

Included

 

[4 variables]

[5 variables]

[6 variables]

Calendar-year controls:

Included

Included

Included

 

[17 variables]

[17 variables]

[17 variables]

 R2:

20.7 %

21.9 %

23.9 %

 Observations:

205 fund-years

216 fund-years

210 fund-years

This table reports the estimation of Eq. (1). The dependent variable is the natural log of Common Equity Raised. The estimation focuses on the contribution of contract design variables to the fund’s common equity raised during three periods: the first five, six and seven fund-years. Each sample is a balanced panel that considers only funds which survive the sample period, including 41, 36 and 30 funds for the five, six and seven fund-year periods respectively. The estimation method is ordinary least squares. The Χ2 test statistic and respective statistical significance for the estimated coefficients are generated by the standard errors from the diagonal of the White heteroscedasticity-consistent estimator of the covariance matrix. All variables are defined in the notes to Table 2. Included in each estimation are fund-age indicator variables, controlling for fixed effects per fund-year, and calendar-year indicator variables, controlling for fixed effects over time (1994–2011)

***, ** and * indicate statistical significance for the estimated coefficients at the 1 %, 5 % and 10 % levels, respectively

Table 4

Operating efficiency

Sample horizon:

5 Fund-years

6 Fund-years

7 Fund-years

Variable

Coefficient

(Χ2)

Coefficient

(Χ2)

Coefficient

(Χ2)

 Constant

0.146

***

(7.3)

0.114

***

(18.1)

0.022

 

(1.5)

 High Commissions

−0.002

 

(0.0)

0.014

 

(1.4)

−0.002

 

(0.1)

 High Asset Mgmt Fees

−0.030

***

(12.6)

−0.038

***

(19.8)

−0.024

***

(13.6)

 High Acquisition Fees

−0.037

***

(15.6)

−0.046

***

(28.3)

−0.037

***

(22.9)

 Long Horizon

−0.025

***

(7.1)

−0.018

**

(3.9)

−0.008

 

(1.4)

Fund-age controls:

Included

Included

Included

 

[4 variables]

[5 variables]

[6 variables]

Calendar-year controls:

Included

Included

Included

 

[17 variables]

[17 variables]

[17 variables]

 R2:

37.4 %

33.7 %

43.1 %

 Observations:

205 fund-years

216 fund-years

210 fund-years

This table reports the estimation of Eq. (2). The dependent variable is Operating Efficiency. The estimation focuses on the contribution of contract design variables to the fund’s Operating Efficiency over three periods: the first five, six and seven fund-years. Each sample is a balanced panel that considers only funds which survive the sample period, including 41, 36 and 30 funds for the five, six and seven fund-year periods respectively. The estimation method is ordinary least squares. The Χ2 test statistic and respective statistical significance for the estimated coefficients are generated by the standard errors from the diagonal of the White heteroscedasticity-consistent estimator of the covariance matrix. All variables are defined in the notes to Table 2. Included in each estimation are fund-age indicator variables, controlling for fixed effects per fund-year, and calendar-year indicator variables, controlling for fixed effects over time (1994–2011)

*** and ** indicate statistical significance for the estimated coefficients at the 1 % and 5 % levels, respectively

Barber et al. (2005) find that mutual fund investors are sensitive to high front-end expenses, including brokerage commissions and acquisition fees. If equity flows are found to be insensitive to front-end fees, it is likely due to the limited ability of investors to distinguish marketing efforts from performance (Golec 2003). The specification in Eq. (1) proposes the amount of common equity raised as a function of the set of contract design variables.
$$ \begin{array}{*{20}c} {\ln \left( {Common\;Equity\;Raise{d_j}} \right)={\beta_0}+{\beta_1}\cdot High\;Commissions+{\beta_2}\cdot High\;Asset\;Mgmt\;Fees} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_3}\cdot High\;Acquisition\;Fees+{\beta_4}\;Long\;} \\ \end{array}Horizon+\sum\nolimits_{i=1995}^{2011 } {{\beta_{4+i-1994 }}} \cdot Calendar\text{-}yea{r_i}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+\sum\nolimits_{j=1}^k {{\beta_{j+22 }}\cdot Fund\text{-}yea{r_j}+\varepsilon .} } \\ \end{array}} \hfill \\ \end{array} $$
(1)

The model presented above is similar to that of Barber et al. (2005) where new equity to the fund is specified as a function of expenses and fees with controls for fund age. The differences are that historic returns and their volatility are not included above (since they are unobservable for non-listed funds), and that we are able to make distinctions for specific categories of expenses given the consistent nature of fee structures in public non-listed REITs. High Commissions evaluates whether the selling commission is an effective incentive to the independent broker-dealers who promote these securities in competition with other products. High Asset Mgmt Fees and High Acquisition Fees consider whether investors demonstrate sensitivity to the right-tail of the distribution in fees disclosures. Long Horizon examines whether investors respond to the finite horizon signaled by managers in the prospectus.

Equation (2) follows a similar specification to Eq. (1) to identify the impact of contract design on the Operating Efficiency ratio, measuring the fund’s success at generating revenue per dollar invested.
$$ \begin{array}{*{20}c} {Operating\ Efficienc{y_j}={\beta_0}+{\beta_1}\cdot High\ Commissions+{\beta_2}\cdot High\ Asset\ Mgmt\ Fees} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_3}\cdot High\ Acquisition\ Fees+{\beta_4}\cdot Long\ Horizon} \\ \end{array}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+\sum\nolimits_{i=1995}^{2011 } {{\beta_{4+i-1994 }}\cdot Calendar\text{-}yea{r_i}+\sum\nolimits_{j=1}^k {{\beta_{j+22 }}\cdot Fund\text{-}yea{r_j}+\varepsilon .} } } \\ \end{array}} \hfill \\ \end{array} $$
(2)

The contract variables included in Eq. (2) consider whether the incentives offered to broker-dealers and management are related to fund performance. Excessive fees and up-front selling commissions could have a negative impact on performance since they limit the funds available to invest in real estate and subsequently distribute to investors. On the other hand, higher fees may serve as a quality signal if managers are only able to charge high fees when they can recover the cost with superior performance. In the literature on mutual funds, Gil-Bazo and Ruiz-Verdú (2009) document evidence for a negative relationship between fees and performance. Funds with lower expected performance strategically set higher fees to target investors who have low performance sensitivity.

Ooi et al. (2007) argue that the finite-life structure limits growth potential for REITs. In Goebel and Kim (1989), finite-life REITs underperform a portfolio of infinite-life REITs. Ambrose and Linneman (1998) noticed that by 1996 all new exchange-listed REITs are organized with infinite life. Since non-listed REITs organize as finite-life funds, the inclusion of Long Horizon in Eq. (2) evaluates whether the more passive liquidity target impacts operating performance, measured as revenue generated from investment.

Following the initial common equity raise and revenue generated from investment, specified in Eqs. (1) and (2) as dependent on contract design, the underlying fundamentals for the public non-listed REIT begin to develop and management implements their dividend policy. The responsiveness of these distributions to the evolving fundamentals for public non-listed REITs is the focus for the estimation in Eq. (3).
$$ \begin{array}{*{20}c} {Distribution{s_j}={\beta_0}+{\beta_1}\cdot Operating\ Efficienc{y_j}+{\beta_2}\cdot Operating\ Cash\ Flo{w_j}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_3}\cdot Dividend\ Reinvestment{s_j}+{\beta_4}\cdot Common\ Equity\ Growt{h_j}} \\ \end{array}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_5}\cdot Leverage\ Rati{o_j}+\sum\nolimits_{i=1995}^{2011 } {{\beta_{5+i-1994 }}\cdot Calendar\text{-}yea{r_i}} } \\ \end{array}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+\sum\nolimits_{j=1}^k {{\beta_{j+23 }}\cdot Fund\text{-}yea{r_j}+\varepsilon .} } \\ \end{array}} \hfill \\ \end{array} $$
(3)

The dependent variable is Distributions, measured as the annual dividend declarations per share, which is often considerably greater than distributions paid from the consolidated statement of cash flows since distribution reinvestment plans allow the funds to pay a sizeable percentage of each distribution as non-cash stock dividends. For exchange-listed REITs, Hardin and Hill (2008) proposed the determinants of excess dividends as fund size, leverage and Q – although market values are lacking for non-listed funds. Michaely and Roberts (2012) consider dividend payouts for non-listed firms as a function of revenue growth, firm size, leverage and return-on-assets. The specification above is similar with the exceptions that revenue growth is replaced with measures for fund flows, size is proxied by fund-age indicators, and return-on-assets is decomposed into its operating efficiency and cash flow components. The number of shares is standardized to an initial share price of $10 per share, adjusting for subsequent reverse stock splits and for the minority of public non-listed REIT offerings at a price other than $10 per share.

Related to the nominal distribution declarations is the issue that these amounts are often in excess of cash flow from operations. Sustainable Distributions is a binary dependent variable, identifying distributions that are covered by cash flow from operations, and the estimation method is a fixed-effects probit model. A linear specification for the probit model is outlined in Eq. (4), which considers the probability of Sustainable Distributions in a given fund-year as a function of the underlying fundamentals.
$$ \begin{array}{*{20}c} {Sustainable\,Distribution{s_j}={\beta_0}+{\beta_1}\cdot Operating\ Efficienc{y_j}+{\beta_2}\cdot Operating\ Cash\ Flo{w_j}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_3}\cdot Dividend\ Reinvestment{s_j}+{\beta_4}\cdot Common\ Equity\ Growt{h_j}} \\ \end{array}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_5}\cdot Leverage\ Rati{o_j}+\sum\nolimits_{i=1995}^{2011 } {{\beta_{5+i-1994 }}\cdot Calendar\text{-}yea{r_i}} } \\ \end{array}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+\sum\nolimits_{j=1}^k {{\beta_{j+23 }}\cdot Fund\text{-}yea{r_j}+\varepsilon .} } \\ \end{array}} \hfill \\ \end{array} $$
(4)

The independent variables in Eq. (4) are identical to those detailed for Eq. (3) and with analogous implications.

Following distributions and reinvestments, some shareholders recognize a demand for liquidity and one of the only options is available through the redemption plan. However, most funds do not begin operations with an open redemption plan and require some time to pass before processing redemption requests. In other cases, the redemption plan is delayed or never opened at all. Initiate Redemptions measures the months from the date that the initial offering is declared effective by the SEC until the date that the redemption plan actually begins to repurchase shares from investors. A linear specification for the probability that the fund will initiate the redemption plan is provided in Eq. (5).
$$ \begin{array}{*{20}c} {Initiate\ Redemptions={\beta_1}\cdot Operating\ Efficienc{y_j}+{\beta_2}\cdot Operating\ Cash\ Flo{w_j}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_3}\cdot Dividend\ Reinvestment{s_j}+{\beta_4}\cdot Common\ Equity\ Growt{h_j}} \\ \end{array}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_5}\cdot Leverage\ Rati{o_j}+\varepsilon .} \\ \end{array}} \hfill \\ \end{array} $$
(5)

The initial prospectus for many public non-listed REITs establishes a connection between the ability to fund redemption requests and the demand for shares offered through the distribution reinvestment plan. The inclusion of Dividend Reinvestments in Eq. (5) attempts to establish whether this relationship is empirically meaningful. Operating Efficiency and Operating Cash Flow evaluate whether the ability of a public non-listed REIT to initiate the redemption plan is related to metrics for operating performance, observed early in the fund life. Common Equity Growth considers whether there is a relationship between continued access to common equity and the decision to initiate redemptions. Leverage Ratio attempts to isolate the contribution that can be attributed to capital structure policy.

Even for funds that do initiate the redemption plan, there is a significant risk that the plan could become maxed out, offered at a significantly lower price, suspended or even cancelled altogether. Constrained Redemptions equals one during fund-years when such issues for the redemption plan are encountered, except when the constraints to redemption are in accordance with the plan of liquidation, and zero otherwise. Equation (6) provides a linear specification of the probit model for the probability of Constrained Redemptions.
$$ \begin{array}{*{20}c} {Constrained\ Redemption{s_j}={\beta_0}+{\beta_1}\cdot Operating\ Efficienc{y_j}+{\beta_2}\cdot Operating\ Cash\ Flo{w_j}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_3}\cdot Dividend\ Reinvestment{s_j}+{\beta_4}\cdot Common\ Equity\ Growt{h_j}} \\ \end{array}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_5}\cdot Leverage\ Rati{o_j}+} \\ \end{array}\sum\nolimits_{i=1995}^{2011 } {{\beta_{5+i-1994 }}\cdot Calendar\text{-}yea{r_i}} } \hfill \\ {\begin{array}{*{20}c} {} & {} & {+\sum\nolimits_{j=1}^k {{\beta_{j+23 }}\cdot Fund\text{-}yea{r_j}+\varepsilon .} } \\ \end{array}} \hfill \\ \end{array} $$
(6)

Funds that never initiate redemption plans are deleted from the samples estimated in Eq. (6) so that only funds who accept redemptions at some point during the sample horizon are considered. According to the specification, the probability that the redemption plan will become constrained after opening could be attributed to diminished operating performance, weak subscription to the dividend reinvestment plan, a loss in access to the common equity channels, or resulting from a suboptimal capital structure. In Berk and Green (2004), mutual fund outflows cause liquidations. The difference for public non-listed REITs is that through redemption suspensions managers control a mechanism that brings fund outflows to a halt in order to prevent liquidation. As a result, it is expected that the likelihood of Constrained Redemptions will be inversely related to fund inflows.

If the redemption plan is never opened or becomes constrained after opening then investors have few alternatives for liquidity and typically must wait for a liquidity event to occur. A number of vulture capital funds are aware of the frustration faced by investors who have no liquidity options and a fund with a redemption plan that becomes constrained is typically met with an unfriendly tender offer soon thereafter. The tender offer occurs at a significant discount to the initial share price (e.g., $2 per share), targeting the most liquidity sensitive investors. Any shares collected can be held until liquidation. Thus, the likelihood that the public non-listed REIT will accomplish a liquidity event in a given period is the final estimation of interest, regarding illiquidity risk.

Liquidation measures the months from the date that the initial offering is declared effective by the SEC until a plan of liquidation is approved. Chan et al. (2006) estimate the probability of hedge fund liquidation as a function of fund age, size, returns and fund flows. Unobservable returns are proxied by operating efficiency and operating cash flow combined with the use of leverage. Equation (7) provides a linear specification for the probability of liquidation in a given period as a function of the fundamentals as observed during certain periods.
$$ \begin{array}{*{20}c} {Liquidation={\beta_1}\cdot Operating\ Efficienc{y_j}+{\beta_2}\cdot Operating\ Cash\ Flo{w_j}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_3}\cdot Dividend\ Reinvestment{s_j}+{\beta_4}\cdot Common\ Equity\ Growt{h_j}} \\ \end{array}} \hfill \\ {\begin{array}{*{20}c} {} & {} & {+{\beta_5}\cdot Leverage\ Rati{o_j}+\varepsilon .} \\ \end{array}} \hfill \\ \end{array} $$
(7)

The estimation of Eq. (7) considers whether the set of underlying fundamentals have any predictive relation to the likelihood of shareholder liquidity. Based on existing literature, the compensation contract variables are expected to be endogenous by influencing variables for fund flows and performance, which in turn may impact liquidation outcomes. The treatment in this study evaluates the contract variables in separate estimations through their impact on Common Equity Growth and Operating Efficiency. The estimations for liquidation outcomes then do not include the contract variables since the expected impact is indirect and is delivered through the fund performance channel.

To address potential issues with endogeneity, Eqs. (1) and (2) include only the set of contract variables which are fixed at origination and exogenous to fund flows and performance variables. While the contract components may be determined simultaneously, the variable measurements result in relatively low correlations. In a given period, cash flow from assets occurs as a result of investment which is then transferred as cash flow to shareholders and creditors. Operating Efficiency and Operating Cash Flow represent cash flow from assets and, as a result, should be exogenous to each of the shareholder outcomes. The remaining concern is that Common Equity Growth and Dividend Reinvestments may be endogenous. To test for endogeneity (in unreported analysis), Common Equity Growth and Dividend Reinvestments are estimated in a first-stage using the set of contract variables and fixed effects from the right-hand side of Eq. (1) as regressors. The residuals from these estimations are collected and added to the estimations of Eqs. (3) thru (7) for each of the samples considered. In all cases, the error terms for Common Equity Growth and Dividend Reinvestments do not have a significant coefficient in the respective estimations.

To maximize observations in a balanced panel of fund-years, the estimation of Eqs. (1) thru (4) and (6) considers sample horizons thru k = fund-year 5, 6 and 7. The estimation method is ordinary least squares and the standard errors used to calculate the statistical significance of coefficients are collected from the White heteroscedasticity-consistent estimator of the covariance matrix for robustness. Calendar-yeari and Fund-yearj are indicator variables controlling for the fixed effects of industry timing and fund age. In Eqs. (5) and (7), the data is right-censored with the non-listed REIT sample since not all funds realize a liquidity event or initiate redemptions during the observation period thru 2011, and a Cox proportional hazard model is used. In an effort to link liquidity outcomes to deterministic managerial incentives, the observation periods are early in the fund life, including fundamentals at fund-year j = 2 and 3, where the number of observations available includes 72 and 59 funds in the sample respectively.20

Empirical Results

Results from the estimation of Eq. (1) are reported in Table 3. The specification is for the log of common equity raised per year and the sample periods considered are for the first 5, 6 and 7 fund-years, including only funds which survive the respective periods. The estimation controls for annual differences in the ability to raise common equity as a public non-listed REIT. Those annual differences for the average fund in the industry are attributable to the industry’s dynamic exposure and acceptance, expected returns on alternative investments, and increased intra-industry competition over time. In addition to calendar-year fixed effects, the estimation also controls for differences in the ability to raise common equity that are the result of a fund’s age at each point during the sample period. Those changes are non-linear with Common Equity Raised at its peak by the fourth 10-K filing. The average adjustment at each age relative to the first year in a fund’s life is controlled by the fund-year indicator variables.

Along with controlling for fixed effects, a set of four variables for contract design are included in Eq. (1). The contract variables consider sensitivities to selling commissions, asset management and acquisition fees, and length of investment horizon. From this set of independent variables, the only variable to demonstrate a consistent statistically significant impact on the fund’s ability to raise common equity is High Commissions. The coefficient for High Commissions is positive and significant estimated at 2.211 in the sample covering the initial five fund-years. The interpretation is that, controlling for other factors included in the model, a fund offering a selling commission to broker-dealers of more than 6 % is expected to raise more than nine times the amount of common equity during any given fund-year relative to one that offers a commission no greater than 6 %.21 Apart from industry timing, this appears to be the only factor in the considerations for contract design to matter. The result confirms that the industry’s success in raising significant amounts of new capital from retail equity investors is due to the fact that subscription to public non-listed REITs persists as a high commission product for broker-dealers selling alternative investments. This result is surprising and directly at odds with Barber et al. (2005) who find that investors are sensitive to high brokerage commissions on mutual fund products. The positive response to high commission rates is likely due to the role of retail investors which suggests that there is selection bias in the behavior of common equity growth for non-listed REITs, and there are limits to extending the implications from fund flows to other non-listed funds if retail investors are not the primary source of subscriptions.

The next step in the empirical analysis considers whether the same set of contract design variables have an impact on operating performance proxied by Operating Efficiency, which accounts the success at generating revenue from each dollar invested in assets. Results from the estimation of Eq. (2) are provided in Table 4. These results reveal that both High Asset Mgmt Fees and High Acquisition Fees have a significant and negative impact, consistent for all three estimation periods. A fund charging asset management fees at 1 % or higher can expect the Operating Efficiency ratio to be reduced by an estimated 2.4 % to 3.8 %. The Operating Efficiency ratio measures the amount of revenue generated per $1 of asset investment. In later empirical analysis presented in the remainder of this study, Operating Efficiency is discovered to serve as a highly relevant metric for the fund’s performance, impacting the fund’s ability to pay distributions and the probability that those distributions will be sustainable. Early behavior for Operating Efficiency is shown to have a deterministic impact on the fund’s success at initiating redemption plans and on the probability of achieving a liquidity event. In addition to the negative impact from high asset management fees, High Acquisition Fees – defined as those greater than 3 % – are found to have a negative and significant impact on Operating Efficiency. High Acquisition Fees reduce Operating Efficiency during the initial years of a fund’s life by an estimated 3.7 % to 4.6 %. Thus, asset management fees and acquisition fees above specific thresholds effectively limit the public non-listed REITs ability to generate revenue from each dollar invested in assets. This result is consistent with evidence from Carhart (1997) and Gil-Bazo and Ruiz-Verdú (2009) who find that high fees on mutual funds lead to underperformance.

The initial conditions for the ability to raise common equity and to generate revenue from investments are determined by the compensation contract; although it is different factors that are found influence the two outcomes. In the long-run, the ability to generate returns for investors is dependent on performance. Equation (3) considers the determinants of distributions per share, standardized to a $10 initial share price, and the estimation results are presented in Table 5. Dual factors are found to have a positive and significant impact, consistent in all estimations. Those two factors are Operating Efficiency and Operating Cash Flow, consistent with evidence that return on assets is predictive in private equity dividend payouts (Michaely and Roberts 2012). Funds that successfully generate high revenue from each dollar of investment and those that convert an increasing percentage of revenue into cash flow from operations are the ones that can afford to make higher distributions to common equity shareholders. The greatest sensitivity is to the Operating Efficiency ratio, where a 1 % increase in Operating Efficiency leads to an increase in Distributions estimated between 0.953 % and 2.321 %.
Table 5

Distributions

Sample horizon:

5 Fund-years

6 Fund-years

7 Fund-years

Variable

Coefficient

(Χ2)

Coefficient

(Χ2)

Coefficient

(Χ2)

 Constant

−0.065

 

(0.1)

0.055

 

(0.1)

−0.098

 

(0.5)

 Operating Efficiency

0.953

***

(10.7)

1.465

***

(35.1)

2.321

***

(55.1)

 Operating Cash Flow

0.0001

**

(5.1)

0.0001

***

(14.3)

0.0001

***

(8.8)

 Dividend Reinvestments

0.124

 

(1.1)

0.058

 

(0.3)

0.074

 

(0.5)

 Common Equity Growth

0.00001

 

(0.0)

−0.007

 

(0.4)

−0.003

 

(0.1)

 Leverage Ratio

−0.125

**

(4.5)

−0.093

*

(3.1)

0.077

 

(1.1)

Fund-age controls:

Included

Included

Included

 

[4 variables]

[5 variables]

[6 variables]

Calendar-year controls:

Included

Included

Included

 

[17 variables]

[17 variables]

[17 variables]

 R2:

30.5 %

38.2 %

43.3 %

 Observations:

205 fund-years

216 fund-years

210 fund-years

This table reports the estimation of Eq. (3). The dependent variable is Distribution Rate. The estimation focuses on the influence from the fund’s evolving fundamentals on the distributions per share over three periods: the first five, six and seven fund-years. Each sample is a balanced panel that considers only funds which survive the sample period, including 41, 36 and 30 funds for the five, six and seven fund-year periods respectively. The estimation method is ordinary least squares. The Χ2 test statistic and respective statistical significance for the estimated coefficients are generated by the standard errors from the diagonal of the White heteroscedasticity-consistent estimator of the covariance matrix. All variables are defined in the notes to Table 2. Included in each estimation are fund-age indicator variables, controlling for fixed effects per fund-year, and calendar-year indicator variables, controlling for fixed effects over time (1994–2011)

***, ** and * indicate statistical significance for the estimated coefficients at the 1 %, 5 % and 10 % levels, respectively

In Table 5, some variables appear to have no effect on the fund’s ability to pay distributions, including Common Equity Growth and Dividend Reinvestments. There is no evidence to support arguments that the dividends paid to public non-listed REITs are related to new equity raised per share in the same period, or that the level of subscriptions to the non-cash dividend reinvestment plans enable the industry to pay higher distributions than otherwise possible.

The sustainability of dividends addresses the probability that declared distributions are covered by cash flow from operations. Results from estimations for the probit model of Sustainable Distributions, specified in Eq. (4), are presented in Table 6. The findings reveal that the same two factors enabling funds to pay higher dividends, Operating Efficiency and Operating Cash Flow, are the two factors that increase the likelihood of Sustainable Dividends. Again, the greatest sensitivity is to the Operating Efficiency ratio, where an increase by 10 % leads to an increase in the z-score for Sustainable Dividend estimated between 0.7279 and 1.0565.
Table 6

Sustainable dividends

Sample horizon:

5 Fund-years

6 Fund-years

7 Fund-years

Variable

Coefficient

(Χ2)

Coefficient

(Χ2)

Coefficient

(Χ2)

 Constant

−7.046

 

(0.0)

−8.612

 

(0.0)

−3.775

***

(15.0)

 Operating Efficiency

7.279

***

(12.5)

8.990

***

(18.1)

10.565

***

(17.8)

 Operating Cash Flow

0.809

***

(10.9)

0.873

***

(13.2)

0.894

***

(13.8)

 Dividend Reinvestments

0.492

 

(0.6)

0.498

 

(0.7)

0.112

 

(0.0)

 Common Equity Growth

1.078

 

(2.2)

1.137

 

(2.4)

0.943

 

(1.5)

 Leverage Ratio

0.486

 

(1.8)

0.506

 

(1.9)

0.647

 

(2.4)

Fund-age controls:

Included

Included

Included

 

[4 variables]

[5 variables]

[6 variables]

Calendar-year controls:

Included

Included

Included

 

[17 variables]

[17 variables]

[17 variables]

 McFadden’s R2:

34.5 %

34.4 %

31.7 %

 Observations:

205 fund-years

216 fund-years

210 fund-years

This table reports the estimation of Eq. (4). The dependent variable is Sustainable Distribution. The estimation focuses on the influence from the fund’s evolving fundamentals on the likelihood that the distribution declarations are covered by operating cash flow over three periods: the first five, six and seven fund-years. Each sample is a balanced panel that considers only funds which survive the sample period, including 41, 36 and 30 funds for the five, six and seven fund-year periods respectively. The estimation method is a probit regression. All variables are defined in the notes to Table 2. Included in each estimation are fund-age indicator variables, controlling for fixed effects per fund-year, and calendar-year indicator variables, controlling for fixed effects over time (1994–2011)

*** indicates statistical significance for the estimated coefficients at the 1 % level

Once an investor has subscribed and observes the distribution policy, events unfold that may cause an individual investor to have demand for liquidity and one of the only options available is according to the fund’s own share redemption plan. The probability that a fund will initiate the redemption plan is the focus of Eq. (5) and the results from the estimation of the proportional hazard model are provided in Table 7. Funds with higher levels of subscription to the plans for Dividend Reinvestments by fund-years two and three are significantly more likely to initiate redemptions in a given period. The reinvestment plan matches investors seeking to sell with those enrolled for repurchase. Additionally by fund-year three, funds with a high Leverage Ratio and low Operating Cash Flow are significantly less likely to initiate redemptions. Of the 72 public non-listed REITs with at least two fund-years of data available, 54 funds had initiated redemption plans and the average time to opening was 12 months. 18 funds had not yet initiated their redemption plans, averaging more than 30 months since being declared effective securities registrations by the SEC.
Table 7

Initiate redemptions

Variables measured at:

Fund-year 2

Fund-year 3

Variable

Coefficient

(Χ2)

Coefficient

(Χ2)

 Operating Efficiency

−1.829

 

(0.4)

−4.898

 

(2.3)

 Operating Cash Flow

0.009

 

(0.8)

0.698

**

(6.3)

 Dividend Reinvestments

2.364

***

(9.4)

2.559

***

(7.5)

 Common Equity Growth

1.429

 

(1.0)

−5.247

 

(1.5)

 Leverage Ratio

−0.747

 

(1.7)

−1.166

 

(2.7)

 McFadden's R2:

3.6 %

6.1 %

 Observations:

72 funds

59 funds

This table reports the estimation of Eq. (5). The dependent variable is Initiate Redemptions, which equals the number of months from the initial registration declared effective to the redemption plan is opened for share repurchases. The estimation focuses on the influence from the fund’s fundamentals measured at the second and third fund-year. Each sample includes only funds with data available for each fund-year. The estimation method is for a Cox proportional hazard model, since the data is right-censored and not all funds initiate redemption plans during the observation horizon. All variables are defined in the notes to Table 2

***, **and * indicate statistical significance for the estimated coefficients at the 1 %, 5 % and 10 % levels, respectively

Even if a fund is successful in opening the redemption plan, investors are not guaranteed liquidity since the plan can become constrained by either reaching the limit for redemption requests, substantially discounting the ask price for repurchases, or suspending or cancelling the redemption program in the future. By fund-year six, more than 44.4 % funds have Constrained Redemptions for reasons other than liquidation. The estimation of Eq. (6) reports in Table 8, which is the probit fixed-effects model for the probability that a fund will have Constrained Redemptions during a given fund-year. The factor found to have a consistent significant increase to the probability of Constrained Redemptions is a loss in access to the channel for Common Equity Growth. The result pairs with evidence of the relation between mutual fund flows and liquidations (Berk and Green 2004); managers of public non-listed REITs exercise the option of closing the gate on redemptions once equity inflows are lost. Of the 36 funds with at least six fund-years available, 16 no longer have proceeds from equity by year six and 56.3 % of those funds have Constrained Redemptions. For the remaining 20 with continued access to common equity by year six, 35 % have Constrained Redemptions.
Table 8

Constrained redemptions

Sample horizon:

5 Fund-years

6 Fund-years

7 Fund-years

Variable

Coefficient

(Χ2)

Coefficient

(Χ2)

Coefficient

(Χ2)

 Constant

−2.426

 

(0.0)

10.243

 

(0.0)

5.661

 

(0.0)

 Operating Efficiency

−7.243

 

(1.3)

−38.694

 

(1.3)

−16.190

*

(3.6)

 Operating Cash Flow

−0.005

 

(0.1)

−0.003

 

(0.0)

−0.004

 

(0.1)

 Dividend Reinvestments

4.611

 

(2.2)

6.459

 

(1.6)

−0.689

 

(0.1)

 Common Equity Growth

−158.600

**

(5.1)

−135.000

*

(3.7)

−125.100

***

(7.5)

 Leverage Ratio

2.964

 

(1.3)

2.520

 

(0.5)

0.043

 

(0.0)

Fund-age controls:

Included

Included

Included

 

[4 variables]

[5 variables]

[6 variables]

Calendar-year controls:

Included

Included

Included

 

[17 variables]

[17 variables]

[17 variables]

 McFadden’s R2:

86.2 %

88.4 %

83.7 %

 Observations:

190 fund-years

204 fund-years

196 fund-years

This table reports the estimation of Eq. (6). The dependent variable is Constrained Redemptions. The estimation focuses on the influence from the fund’s evolving fundamentals on the likelihood that the redemption plan will become constrained over three periods: the first five, six and seven fund-years. Each sample is a balanced panel that considers only funds which both initiate redemptions and survive the sample period, including 38, 34 and 28 funds for the five, six and seven fund-year periods respectively. The estimation method is for a probit model. All variables are defined in the notes to Table 2. Included in each estimation are fund-age indicator variables, controlling for fixed effects per fund-year, and calendar-year indicator variables, controlling for fixed effects over time (1994–2011)

***, ** and * indicate statistical significance for the estimated coefficients at the 1 %, 5 % and 10 % levels, respectively

Apart from redemption plans, inefficient secondary markets, and heavily discounted tender offers by vulture capitalists, the access to liquidity for patient investors remains in control of management who must decide when to pursue a liquidity event and by which method. Equation (7) specifies a proportional hazard model for the probability that a liquidity event will occur in a given period as a function of the fundamentals observed for 72 funds at fund-year two and for 59 funds observed at fund-year three. The results for Eq. (7) estimations are provided in Table 9. There are 72 funds with at least two fund-years of data available, of which 20 have liquidated with an average time to liquidation at 7.5 years. The 52 funds that remain unliquidated have an average life equal to four fund-years. Operating Efficiency observed at the second fund-year has a positive and significant impact on the probability of liquidation. Considering the sample available thru fund-year three, there are 39 censored funds yet to liquidate with an average maturity of six fund-years. Factors observed at fund-year three to have a positive and significant predictive relation to the likelihood and proximity to a future liquidation event include Operating Efficiency, Operating Cash Flow, and Common Equity Growth – each with positive sign.
Table 9

Liquidations

Variables measured at:

Fund-year 2

Fund-year 3

Variable

Coefficient

(Χ2)

Coefficient

(Χ2)

 Operating Efficiency

12.464

**

(4.9)

18.536

***

(9.7)

 Operating Cash Flow

0.021

 

(0.1)

1.238

***

(8.1)

 Dividend Reinvestments

0.137

 

(0.0)

0.026

 

(0.0)

 Common Equity Growth

2.219

 

(0.6)

17.255

**

(5.2)

 Leverage Ratio

0.308

 

(0.1)

2.052

 

(1.9)

 McFadden’s R2:

5.2 %

12.4 %

 Observations:

72 funds

59 funds

This table reports the estimation of Eq. (7) which considers the influence on the likelihood of liquidation resulting from fund fundamentals measured at the second and third fund-years. Each sample includes only funds with data available for each fund-year. The dependent variable is Liquidation, which equals the number of months from the month that the initial registration is declared effective until the fund initiates a plan of liquidation. The estimation method is for a Cox proportional hazard model, since the data is right-censored and not all funds realize a liquidating event during the observation horizon. All variables are defined in the notes to Table 2

*** and ** indicate statistical significance for the estimated coefficients at the 1 % and 5 % levels, respectively

The result that favorable performance conditions contribute to liquidation outcomes is at odds with hedge fund behavior, where survival is generally more desirable than liquidation. Hedge funds experience relatively short life expectancies (Brown et al. 2001) and high probabilities of liquidation in a given year (Liang 2001; Howell 2001). Poor performance is a common reason for early hedge fund liquidation (Brooks and Kat 2002; Amin and Kat 2003; Getmansky 2004), introducing survivorship bias in the measurement of hedge fund returns (Brown et al. 1999; Baquero et al. 2005). In contrast for non-listed REITs, funds that succeeded in generating sufficient revenue from investment, converting revenue to operating cash flow and continued equity subscriptions are significantly more likely to realize a liquidity event and it is expected to occur at an earlier point. The concept that comprehensive liquidation is a favorable outcome is more closely aligned with VC exits, where the percentage of investments exited via IPO or acquisition measures performance success (Hochberg et al. 2007; Phalippou and Gottschalg 2009). While investment returns are not examined directly in this study it is expected based on the evidence provided, that surviving non-listed REIT funds underperform fund that exit through IPO or acquisition.

Concluding Remarks

This study documents a series for the public non-listed REIT industry using an extensive hand-collection of observations extracted from public filings in the SEC Edgar database, in order to gain insights into the role of managerial incentives and liquidity risk for the rapidly growing non-listed fund sector. The sector is characterized by a lack of liquidity since shares do not trade on organized exchanges, redemption programs do no initiate immediately then may become constrained at any point, and there is reasonable uncertainty surrounding the possibility of future liquidation events.

The sequence of evidence outlined in this study reveals that the most significant factor influencing the ability to raise common equity is high commission rates, which are drastically greater than front-end loads for mutual funds. The positive relation between up-front commissions and equity subscriptions is surprising given earlier evidence of an inverse relation in mutual funds (Barber et al. 2005). It suggests that the retail investor clientele, who represent the dominant source of new equity (Corgel and Gibson 2008), are unable to distinguish marketing efforts from expected performance (Golec 2003). Simultaneously, investors display little to no sensitivity regarding high asset management fees and high acquisition fees, both of which are found to have a significant and negative impact on the fund’s ability to generate revenue from investment (measured by the operating efficiency ratio). The operating efficiency ratio and the ratio of operating cash flow to revenue are discovered to have a deterministic impact on the non-listed fund performance. This discovery is timely for investors and analysts of non-listed funds who are searching for relevant metrics of performance when meaningful share prices and returns are unobserved.

Redemption plans often require time to become effective. The ability to initiate redemptions is found to be positively impacted the operating cash flow ratio and increasing with subscription to the dividend reinvestment plan. An open redemption plan is at risk of later becoming constrained, which is strongly related to the loss in access to common equity growth – analogous to connections between mutual fund outflows and liquidations (Berk and Green 2004). Of the 54 redemption programs that did become effective at some point out of 79 considered, 25 of those programs ultimately became constrained at some point. Patient investors have the option to wait until a plan of liquidation is adopted. However, just 20 out of the 79 funds have actually adopted a plan of liquidation. The probability of liquidation in a given period is positively impacted by the operating efficiency ratio, operating cash flow ratio and access to common equity growth, with measurements taken early in the fund’s life.

Considering the scope of evidence provided in this study, investors should take extra caution when investing in public non-listed REITs. High front-end fees limit the amount available to invest in real estate relative to other real estate investment vehicles. Ongoing fees, including asset management fees and acquisition fees, are found to have a negative impact on performance. Those fees potentially limit the opportunities for managers to liquidate and skew incentives towards maximizing assets under management, keeping assets under management and/or churning assets in place. Policymakers and investment industry regulators should take a close look at whether promotional materials distributed to potential public non-listed REIT investors provide an accurate description of investment performance, access to redemption plans and distribution levels, given that these outcomes can be observed through SEC filings.

It is not practical to conclude that all non-listed funds are problematic and the sequence of estimations outlined in this research provide a foundation for investors and analysts to distinguish risk characteristics for funds within this sector. Investors appear vulnerable in the sense that they demonstrate little sensitivity to distinguishable organizational characteristics. Current and incoming public non-listed REITs should attempt to distinguish themselves from the historic tendencies of the industry. Revised compensation structures could be proposed that reduce the incentives to never liquidate and should be more competitive with similar investments, such as exchange-listed REITs and real estate mutual funds. High front-end fees cause investors to begin with negative returns and the $10 share price reported to investors during the initial periods is potentially misleading. The level of cash flow from operations should be considered before distribution declarations. Illiquidity risks should be addressed including the limitations to redemption plans and the optimal liquidation path for investors.

Empirical research on public non-listed REITs is in its infancy and a number of issues are not fully explored in this study. A reliable measure for investor returns could be constructed and compared with returns on exchange-listed REITs to estimate liquidity premiums and to evaluate liquidation alternatives. Agency problems, corporate governance and finite-horizons should influence dividend behavior, capital structures and optimal investment policy. Such avenues for future research have the potential to contribute to the knowledge base in the broader non-listed fund sector, encompassing many other asset management intermediaries. Research opportunities should expand with time as the sector continues to grow and additional data sources become available, which can be used to evaluate potential selection biases in the observation period, in the relevance of non-listed REITs for other non-listed funds, and in the extension to international equities.

Footnotes
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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© Springer Science+Business Media New York 2013