Non-listed REITs posted a “blockbuster” month of fundraising in April with nearly $1 billion flowing into the sector. According to the latest data from Robert A. Stanger & Company, the year-to-date fundraising total of $2.7 billion (through April) is more than the $1.3 billion raised during the same period in 2018.
The rise in fundraising is due to a combination of factors. The non-listed REIT industry has done some heavy lifting over the past few years to reduce heavy fee structures and improve transparency and reporting. Part of those efforts is due to regulatory compliance. FINRA 15-02, which was introduced in 2016, requires all non-traded REITs and direct participation programs (DPPs) to include more frequent estimated values on investor account statements.
The increased focus on transparency is giving financial advisors and investors more insight into a sector that, in many cases, is performing as well or better than publicly-traded REITs—with the added advantage of less volatility. Non-listed REITs have posted strong numbers over the past three years. At the end of first quarter, NAV REITs were outperforming listed REITs on a three-year period with cumulative returns, including distributions and capital appreciation, at 22.1 percent vs. 19.1 percent, according to the Spring IPA / Stanger Monitor. Lifecyle REITs were trailing with three-year returns at 15.1 percent.
Another factor that has helped to build confidence and credibility is the rise in institutional investment asset managers, such as Blackstone, JLL, CIM and others. “As they have entered this market, coupled with a track record and performance that we can now demonstrate, the retail clients are now stepping up and identifying this as an alternative investment opportunity away from traditional equities,” says Anthony Chereso, president and CEO of the Investment Program Association (IPA).
“I definitely think the regulatory changes with more frequent valuations and institutional players coming in and reducing the fees, that certainly helped the NAV REIT model gain broader adoption,” notes Allan Swaringen, president and CEO of JLL Income Property Trust. “I also think volatility in the equities market and certainly volatility in the listed REIT market is resulting in advisors that are looking for solutions that perform differently than their stock and bond portfolios.”
Tapping new capital sources
Other factors that have helped bolster fundraising momentum is a bigger sales channel that now includes the ability to tap into registered investment advisors, the independent broker-dealer network and the wirehouses, as well as a growing investor pool.
There is a huge opportunity ahead for the non-listed REITs to capitalize on growing allocations to commercial real estate among both institutions and retail investors, says Mark Goldberg, CEO at Griffin Capital Securities. Institutions generally have modest double-digit allocations to commercial real estate vs. the retail investor that typically has 4-5 percent. Investors are increasingly wary of equity markets that are volatile, and potentially fully priced. “That is creating more focus on alternative asset classes, and one of those classes is obviously real estate,” says Goldberg.
Some funds have also initiated structural changes in 2019 that allow them to accept money from foreign capital sources. That activity from foreign investors has helped boost fundraising this year, and it is something that could have a bigger impact on the sector going forward. “With the trend of increased capital flow it tends to beget additional capital flows. So, I think you’re going to see really strong capital flows into real estate products going into the third and fourth quarters,” says Goldberg.
Foreign capital will continue to be an important source of capital, but it pales in comparison to the growing pool of capital from retail investors, adds Chereso. Specifically, the industry is working harder to break into the defined contribution market and provide alternative investment sources to retail investors and advisors building retirement portfolios through self-directed IRAs, 401ks and SEPs.
More dollars flow to NAV REITs
Investors are finding more choices among both NAV and lifecycle REITs. However, the year-to-date data shows a sizable fundraising gap between NAV and lifecycle REITs at $2.3 billion and $392 million respectively. NAV products feature a perpetual structure that offers limited periodic liquidity, while lifecycle REITs have a closed structure that has a specific hold period (typically five to seven years) before executing a liquidity event and returning capital to investors.
Lifecycle REITs have been losing market share to NAV REITs in recent years. The debate is whether that is a cyclical phenomenon, or more of a permanent shift with lifecycle REITs that may be phased out. “We don’t see the lifecycle REIT going away. It will continue to be a viable investment strategy for certain investors,” says Chereso. Some investors like the concept of investing in a portfolio where there is a finite life, he adds.
Lifecycle REIT strategies generally focus on a private to public market exit, such as selling to a public REIT or even listing as a REIT. Given the fact that many public REITs are trading at values below net asset value, that exit strategy is less attractive, notes Goldberg. When there is a cyclical shift where public REIT values are more favorable, it will spur more investment into lifecycle REITs. However, for now, the open-ended daily NAV REITs are the most popular and should be for quite some time, he adds.
That being said, there continues to be fundraising activity for lifecycle REIT products, especially those with an established pipeline. Griffin Capital recently closed a very successful fundraise for its latest lifecycle REIT, Griffin-American Healthcare REIT IV, at $800 million.
Others believe the lifecycle structures will have a more difficult time competing with the NAV REITs going forward. Whereas NAV REITs usually have some “seed assets” or some level of sponsor equity to jumpstart a portfolio, lifecycle REITs generally start from scratch, says Swaringen. Due to new reporting requirements, lifecycle REITs have to conduct their first net asset appraisal in the first 12 months. So, lifecycle REITs have to quickly scale up and there are a lot of initial costs and fees that drag down performance, he says. Fund managers that have a track record to show they can overcome those start-up costs will likely fare better than new entrants in the current climate.