A New REIT IPO
By Mike Roach | September 12, 2007
American Realty Capital Trust filed Form S-11 with the SEC 9/10 to begin the IPO process for a new REIT.
Nicholas S. Schorsch, who resigned in a “mutually agreed upon” move last year from American Financial Realty Trust, the REIT he founded, is moving back into the REIT space with a non-traded REIT which will operate under a similar business model as his former company.
Some Highlights:
Business Model
We focus our investments primarily on the acquisition of freestanding, single-tenant commercial properties net leased to investment grade and other creditworthy tenants. Unlike funds that invest solely in multi-tenant properties, we plan to acquire a diversified portfolio comprised primarily of a large number of single-tenant properties and a smaller number of multi-tenant properties that compliment our overall investment objectives. By acquiring a large number of single-tenant properties, we believe that lower than expected results of operations from one or a few investments will not necessarily preclude our ability to realize our investment objectives of current income to our investors and preservation of capital from our overall portfolio. In addition, we believe that single-tenant commercial properties, as compared to shopping centers, office buildings, malls and other traditional multi-tenant properties, offer a distinct investment advantage since these properties generally require less management and operating capital and have less recurring tenant turnover.
Conflicts of Interest
American Realty Capital Advisors, LLC, as our advisor, will experience conflicts of interest in connection with the management of our business affairs, including the following:
• The management personnel of American Realty Capital Advisors, LLC, each of whom also makes investment decisions for other American Realty Capital-sponsored programs and direct investments, must determine which investment opportunities to recommend to us or another American Realty Capital-sponsored program or joint venture, and must determine how to allocate resources among us and the other American Realty Capital-sponsored programs;
• American Realty Capital Advisors, LLC may structure the terms of joint ventures between us and other American Realty Capital-sponsored programs;
• We have retained American Realty Capital Properties, LLC, an affiliate of American Realty Capital Advisors, LLC, to manage and lease some or all of our properties;
• American Realty Capital Advisors, LLC and its affiliates will have to allocate their time between us and other real estate programs and activities in which they are involved; and
• American Realty Capital Advisors, LLC and its affiliates will receive fees in connection with transactions involving the purchase, management and sale of our properties.Our officers and one of our directors also will face these conflicts because of their affiliation with American Realty Capital Advisors, LLC. These conflicts of interest could result in decisions that are not in our best interests. See the “Conflicts of Interest” section of this prospectus for a detailed discussion of the various conflicts of interest relating to your investment, as well as the procedures that we have established to mitigate a number of these potential conflicts.
Debt Risk
Current state of debt markets could have a material adverse impact on our earnings and financial condition
The commercial real estate debt markets are currently experiencing volatility as a result of certain factors including the tightening of underwriting standards by lenders and credit rating agencies and the significant inventory of unsold Collateralized Mortgage Backed Securities in the market. This is resulting in lenders increasing the cost for debt financing. Should the overall cost of borrowings increase, either by increases in the index rates or by increases in lender spreads, we will need to factor such increases into the economics of future acquisitions. This may result in future acquisitions generating lower overall economic returns and potentially reducing future cash flow available for distribution.
In addition, the state of the debt markets could have an impact on the overall amount of capital investing in real estate which may result in price or value decreases of real estate assets. Although this may benefit us for future acquisitions, it could negatively impact the current value of our existing assets.
For the full document, follow this LINK:
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How does a rising cost of capital effect the REIT market?
By Mike Roach | September 5, 2007
Sometimes in life, things get out of whack because of a mass reaction to new information. You are calmly enjoying your meal and your company when the fire alarm goes off. There is a rush out the door, some people get hurt, some who were planning on eating at that restaurant return to their cars and go elsewhere. But you…you were right in the middle of a meal. You don’t want to leave too quickly, because it may have been a test, or a false alarm.
So, thinking it was a false alarm, you decide you want to be one of the first to return - after all, you were enjoying your meal. What if you find, upon returning, that your meal is gone, the management will be happy to replace it, but you will have to pay for the replacement? Or, what if you return and someone else is sitting in your seat enjoying your meal, and if you want to finish you must eat what someone else orders?
The point to this strained analogy is that even if it is a false alarm or an over reaction, you may not be able to expect to just pick up where you left off. Even if it is a false alarm, things may not be the way they were before.
Case in point: Cost of capital. Many REITs that have nothing to do with sub-prime lending went down recently in sympathy with the mortgage REITs. You had a higher than anticipated default rate, then a credit squeeze, then downgrades, then equity downgrades, then another rush for the exits, then a repricing of risk, then another credit crunch, a couple of hedge funds busted, a couple more got rescued…exciting headlines, lots of fun for the talking heads, but nothing to do with my Shopping Center REIT or Industrial Property REIT, right?
Wrong.
Remember, stock and bond markets are CAPITAL MARKETS. You and I use them toward their secondary purpose…we buy and sell securities from other buyers and sellers in a secondary market. Primarily, though, capital markets are how firms raise capital. Especially important for REITs.
REITs, you will recall, pay out 90% of their net income (Funds from operations) as dividends to shareholders, leaving less than 10% for reinvestment. With so little retained earnings to invest in the business for growth, REITs are particularly dependent on the capital markets, because they must sell bonds or stocks to raise money for improvements, acquisitions, repairs, all those things they need to do to maintain and raise revenue.
In my analogy above, you may return to your meal of Shopping Center REIT, because it is not in the sub-prime residential sector, only to find that your Shopping Center REIT can’t raise money as cheaply as it could before… borrowing costs are higher, acquisition money may even be on hold. So in this instance, the stock should not be priced as it was before, when it had access to cheap capital. It should be priced lower, because it will be more expensive to grow revenue, which obviously reduces Net Income (FFO) and dividends paid to its investors.
Capital markets are dynamic and fluid markets, comprised of the individual decisions of millions of investors. In time, the market may discount the effects of increased cost of capital, or may absorb new sources of capital, or may weigh in some other factor to be of greater importance than the increased cost of capital, like immigration patterns or international trade agreements. Prices will once again rise to levels they were before the “sub-prime incident”. Just know that if you return to that market right away, you may not be able to pick up where you left off. Someone else may have eaten your lunch.
In other news:
Real Estate Funds Fall May Have Plus Side
NEW YORK (AP) — Real estate investment trusts have taken a drubbing this year as some investors have grown concerned the real estate portfolios these companies hold are overvalued. But a drop in share prices of REITs could signal an opportunity for investors willing to look under the hood at what a company owns. Read entire article here
Some analysts think the mortgage company’s moves to shore up its finances have stabilized its position, at least for now. Read entire article here
NovaStar Cancels Preferred Offering, Cuts Jobs
NovaStar Financial announced it has canceled a $101 million convertible preferred stock offering after its auditor, Deloitte & Touche, would not agree to the plan unless specific parts were changed to reflect the increase in risk since the credit crunch began. Read entire article here
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Topics: REIT REITS, Mortgage, News | 2 Comments »
I disagree that now is the time to by REITs
By Mike Roach | September 4, 2007
I keep reading commentary on blogs and websites that now is a good time to buy REITs. The reason given: they have fallen quite a bit recently. For many, the analysis stops there. REITs, we’re told, are a rubber ball that are due to bounce back simply because they are lower than they used to be - in other words, their prices only go up.
This type of analysis and commentary is easy to come up with, because it requires no research. Could you not make the same analysis of index funds, steel stocks, automakers…really, saying something might go up because it has come down is no analysis at all.
I’m still looking for reasons why the income streams from REITs should be valued higher now than they have been historically…and can’t come up with any. True, many REITs are trading at a discount to NAV, but historically, investors have purchased REITs for their income streams, not their liquidation value. Discount to NAV is something to consider, but dividend yield has held more weight in the past.
Anyone who says it must go up because it came down may be right…but for the wrong reasons. This is not analysis, it is guesswork (and not even sophisticated guesswork). Be right for the right reasons…find value…answer the questions…minimize uncertainty…don’t let history be your master, but do let it be your guide.
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An interview with REIT legend Martin Cohen
By Mike Roach | August 30, 2007
Asian Investor Magazine writer Jame DiBiasio interviews Martin Cohen of Cohen & Steers.
Cohen & Steers expanded internationally about 10 years ago, and now international REITs make up about half of the portfolio holdings.
He sees value in the US REIT market right now, but not without risk.
“Is the US market now attractive?
Yes. I’d say it’s trading now at a slight discount to asset value. But then you have to ask, where is the general economy headed? If it goes soft, everything’s finished: real estate, industrial stocks, they’ll all have problems. I don’t know which way the economy will go. My sense is we’ll have a slowdown but not a recession, but when I look at housing statistics, it’s clear we’re headed for uncharted territory. How will this impact consumers?”
He is also looking for US REITS to outperform International in 2008.
“How will returns be affected?
Last year saw extraordinary returns. Our global portfolio returned 26.6% in 2006, with the US the strongest performer. So far this year, however, Asia has been the only positive market. Our global portfolio is down -1.4% year to date, and our US portfolio is down -6.6%, although it remains up 14.1% on an annualised basis since inception in 1985. But the Asia component is up 13.1%. That said, there is a good chance the US will outperform other markets in 2008.
IN OTHER NEWS:
Capital Alliance Income Trust Receives Letter of Noncompliance from AMEX.
The delisting of a mortgage REIT: the Sequel? CAA (AMEX)
REITS May Be a Good Buy for Long Term Investors
Prices are down, but values are not cheap yet.
Covenants and Confusion - Moody’s On Debt Markets
Straight from the Horse’s mouth. An Audio interview.
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Topics: REIT REITS, Mortgage, News, Office | No Comments »
REIT prices must come down
By Mike Roach | August 17, 2007
A conversation with some business associates yesterday led around to real estate investments. We discussed hard investments vs. securities investments (buying land vs. buying stocks), valuation, risk, and the concept of fair value.
This conversation led an interesting question which I thought I would address here.
The question,for which there are many competing answers, was: how do you value a REIT (specifically), or any other investment, for that matter?
First of all, value is always determined by buyers, for if a buyer doesn’t see value, no transaction takes place. As a buyer of a REIT, I could look at it in two ways: 1) I value the investment based on an earnings yield, (Dividends), or 2) I value the investment based on the price I expect buyers to pay in the future (Capital Gains). Most investors look at both, but have a bias toward one or the other; e.g. An investor biased toward capital gains would see the dividend as a safety net, whereas an investor biased toward dividends would see capital gains as a bonus.
Historically, REIT investors have been Dividend investors looking for that potential for capital gains. REITs are not structured to function as a proxy for gains in the underlying real estate - you are looking for a stream of rental income, not title to commercial property. Based on cost of capital, legal structure, and long term holdings of the typical REIT, value comes when properties are improved and rents increase, not when the price of the underlying property appreciates.
Given this historical bias, how does the dividend yield of REITS look compared to it’s long term average? I analyzed 20 years worth of data and found that current yield is 250 basis points lower than its long term average. In terms of raw yield, this is the lowest point in the last 20 years. See the chart below.
In addition to being at low yields historically, my research shows that in the last 20 years, REITs have given a 137 basis point premium over the 10 year Treasury rate. This spread is the compensation investors expect to receive for taking on excess risk. The current situation, however, is telling: there is effectively a negative spread . This means that REIT investors are not being compensated for excess risk. You could receive the same yield in no risk Treasuries. This premium over risk free is also at its lowest point in 20 years. See chart below.
In the current yield situation, there are two possibilities that would bring yields back into proportion to their historical averages:
1) Earnings, and therefore dividends, would have to increase, or
2) Prices have to come down.
Given the capital cost and legal structure, not to mention the current real estate and capital markets, REITs lack the ability to substantially grow their earnings. Since they are required by law to pay out 90% of their net earnings as dividends to investors, they do not have the pool of retained earnings to make acquisitions that other corporations do, so they must raise money by borrowing (either bank loans or selling bonds). This is a risky proposition in today’s market environment. So unless they can develop properties and raise rents, they are unlikely to be able to grow their earnings at a high rate.
Add to this the fact that the “LBO premium” that has been built into REIT prices in the past is quickly evaporating, as PE firms need to become much more selective about their buyout targets since they have a substantially tightened pool of capital to work with. In the absence of PE firms stumbling over themselves to take your company private, you as an investor must evaluate the REIT based on its fundamentals, and that means DIVIDENDS.
That leaves the average REIT buyer looking to buy at lower prices in the future, not higher. Lower prices because the long term yield will return to mean. Lower prices because the LBO premium is gone. Lower prices because the cost of capital has increased in the wake of the sub-prime fiasco and the subsequent liquidity crunch.
As I mentioned HERE previously on this blog, Income investors should be wary of REITS because they currently offer no premium over risk free yields, Value investors should avoid because REITs are not at bargain prices, and Growth investors should look elsewhere because the structure of REITs makes it difficult for them to increase their earnings growth rates.
I know there are exceptions to my generalizations, more of which I will be exploring in the future. But as an asset class, I would not be a buyer of REITs until their prices come down. I like being compensated for the risk I take…I think it is a good habit and I encourage it in others.
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In the news today
By Mike Roach | August 15, 2007
US REIT BIDS $1.4 BILLION US FOR TORONTO FIRM
IPC Board unanimously approves Behringer Harvard’s all cash offer.
THORNBURG MORTGAGE SHARES FALL AFTER ANALYST DOWNGRADE
Analysts at Credit Suisse, RBC Capital Markets, Friedman Billings Ramsey, Jefferies & Co. and Piper Jaffray all lowered their ratings
THORNBURG MORTGAGE DELAYS DIVIDEND
Margin calls and difficulty funding mortgage assets.
FITCH PLACES TABERNA PREFERRED FUNDING II, LTD. ON RATING WATCH NEGATIVE
Another CDO backed primarily by trust preferred securities issued by REITs
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Ratings cut for Homebuilders
By Mike Roach | August 14, 2007
“NEW YORK (Reuters) – Fitch Ratings on Monday cut its ratings on Beazer Homes USA Inc. (BZH - NYSE) deeper into junk territory and said it may cut them again, while Moody’s Investors Service said it may also lower the home builder’s rating.”
“Possible accounting restatements, an internal Board of Directors’ investigation and inquiries from the U.S. Attorney’s office and Securities and Exchange Commission (SEC) provide added distraction amidst this difficult housing environment,” Fitch said. (Read Full Article Here)
Next thing you know, Analysts will recommend selling the stock - already down almost 74% YTD.
It seems to me that the time to get out of an investment are when returns (dividends and gains) don’t justify the risk the investor is taking. You want a premium over risk free Treasury returns to compensate you for the additional risk you are taking. Ignoring this formula means you are gambling instead of investing. Hope kills account balances.
In Other News:
HOMEOWNERS PILE OUT OF ADJUSTABLE RATE MORTGAGES
Lenders are backing away from lending at ARM terms as the loans are getting harder to sell.
SCARE COULD CAUSE CHAIN REACTION OF DEFAULTS
The risk this could spread is still very real.
HOW THE GEARS JAMMED IN THE HOUSING MACHINE
Lenders can do kneejerk emotional reactions too.
MORTGAGE REIT FUND HAMMERED BY CREDIT CRUNCH
Fund may have launched at the peak.
HEALTH CARE REITS TO BE ADDED TO DOW JONES WILSHIRE GLOBAL REAL ESTATE INDEXES
DJ changed the rules since these REITs behave more like Real Estate stocks than HealthCare stocks.
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Do I hear an echo?
By Mike Roach | August 7, 2007
In a strange echo of AHM news a week ago, Luminant Mortgage Capital (LUM, NYSE)was halted yesterday as news of margin calls and questions of their ability to continue as an ongoing concern hit the streets. One month ago today, it closed at $10.48 and was paying a $.32 dividend. Now, as I write, shares are trading for $.70 and the dividend payment has been suspended (now that would have been a nice dividend yield!). The problem is the rapid decline of liquidity in the secondary mortgage market, a market that is crucial for mortgage originators to remain in business. If originators can’t sell their loans, they run out of funds to lend, which means their revenue halts, which means they go out of business. You see, mortgage originators aren’t compensated based on the long term profitability of their loans, they have a fee-based model. They make money on origination fees and points collected up front, then they make money when they sell the mortgage for a premium. Without their ability to sell the mortgage in the market, their whole business model crumbles.
Meanwhile, in homebuilder land, BusinessWeek ran a cover story Bonfire of the Builders which highlights some of the problems facing homebuilders in the perfect storm of declining home prices, overbuilding, rising interest rates, declining credit quality, liquidity problems and mortgage default rates. Builders got involved in lending to a degree they never had before, and as things started to turn, their attempts at propping up their revenues led to shortcuts both on the building and the lending side of the business, resulting in builders selling shoddy homes in half-build developments to buyers who couldn’t really afford what they were buying for prices higher than they were worth at credit terms that didn’t compensate investors for risk. The flush of liquidity out of these stocks and markets is just beyond the tipping point. I spent several years as a mortgage originator myself, and I have seen the level some people will stoop to close the next deal. We are well beyond “scratching the surface”, but we haven’t hit bottom yet…
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Why Buy REITS?
By Mike Roach | July 31, 2007
I read Lee Wheeler’s article this morning, and he brings to mind a key question…why buy REITs? (Read article HERE)
Remember when REIT’s were conservative investments held more for their income than for their explosive appreciation? They were part of a diversified portfolio which gave investors exposure to the Real Estate market, and an actual earnings yield that you could put in your pocket.
Somewhere along the way, they became “sexy”, the subjects of LBO rumors, leveraged and marginable “plays”. Their prices skyrocketed and yields plunged, and they became the latest speculation you couldn’t afford to miss. Late 2006, REIT’s were like Rock Stars - front page news, getting invited to all the best parties. But that party ended.
Now, the IYR, the ETF that tracks the US REIT Index, has fallen 27% since February. That’s a whale of a hangover. And they still are yielding less than the 10 year treasury, and with much more volatility, which means they still have a ways to go. For IYR to reach it’s mean historical yield, it may have another 25-30% to fall.
REITs will someday have a place in a diversified portfolio, with consistent earnings and potential for price appreciation. But do they have a place now? You buy income investments for consistency, and REITs are way too volatile. You buy growth stocks for their high growth potential, but REITs are not structured to deliver that. You buy value stocks to capture “earnings at a bargain”, but REITs are no bargain. The historical reason for owning REITs doesn’t apply right now. It seems the party’s over, but the hangover’s not.
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Have you seen the price of AHM?
By Mike Roach | July 31, 2007
Take a look at this data from Yahoo Finance regarding American Home Mortgage Investment Corp. 2.34 PE!!! 26.7% Dividend Yield!!! There’s only one problem…trading has been halted! The E from the PE is not to be trusted! The dividend is not being paid!
| AMER HOME MTG INVT (NYSE:AHM) |
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Shareholders of record were surprised Friday to find that the check was not in the mail. A $.70 dividend had been declared, and was supposed to have been paid Friday, but the company announced it would not be paying the dividend when scheduled, and gave no indication when it would be paid. According to the company:
“The disruption in the credit markets in the past few weeks has been unprecedented in the Company’s experience and has caused major write-downs of its loan and security portfolios and consequently has caused significant margin calls with respect to its credit facilities.”
Analyst Bose George, with Keefe, Bruyette & Woods, breaks down the issues for us:
“At the end of 1Q the company had $596 million of below AAA-rated securities. Of this total $366 million was below investment grade. This includes the company’s $183 million residual. Our model now assumes a 50% loss rate on the below investment grade securities, a 30% loss rate on the BBB-rated securities, a 20% loss rate on the A-rated securities and a 10% loss rate on the AA-rated securities. This results in a total loss of $193 million which runs through the income statement. We note that there is no tax offset to this because these securities are held at the REIT.”
It’s too bad nobody could see this coming…
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