A Deeper Look at Cottonwood Residential & AR Global
September 25, 2019 | James Sprow | Blue Vault
On September 10, 2019, Blue Vault presented a Webinar on the performance of the 15 nontraded REITs sponsored by AR Global (formerly American Realty Capital) and Cottonwood Residential, the sponsor of Cottonwood Communities, a nontraded REIT that was declared effective in August 2018.
Cottonwood Communities
Cottonwood Communities is currently raising capital and investing in both multifamily apartment communities that are income-producing, stabilized assets, and growth-oriented investments in preferred equity, mezzanine loans and equity investments in properties to be developed into multifamily communities. The REIT plans to target roughly 65% in stabilized multifamily communities and 35% in growth-oriented investments.
Cottonwood Communities is offering Class A and Class T shares with no upfront loads for investors. The sponsor terms this fee structure as “NTR 2.0” because of the way the advisor’s incentives are structured. In lieu of upfront fees, the advisor has contingent acquisition fees and financing fees that are paid only after shareholders receive a return of at least 6% on invested capital. There is a promotional interest of 15% of net income and cash distributions after shareholders receive the same 6% return. Other fees, such as property management fees (up to 3.5% of annual gross revenues) and asset management fees (1.25% of gross AUM) are typical for the industry.
Cottonwood Communities purchased a 245-unit apartment complex in West Palm Beach, Florida, in May 2019. Occupancy was 84.1% at closing, and the $67 million purchase was funded partially by a $36 million credit facility at 3.93% and interest only for 10 years.
In July 2019 the REIT invested in a $10 million 9.50% + LIBOR floor of 2.50% note that will partially finance a 366-unit apartment complex in Allen, Texas. That note matures in 2021, with interest-only payments until maturity. The developer has a senior loan of $45.5 million from JLL and will fund $17.9 in equity.
On August 15 the REIT entered a joint venture of up to $9.9 million with Milhaus, LLC to develop a 254-unit multifamily community in Ybor City, Florida.
The REIT’s stabilized apartment complex ($67 million) and two financing investments ($10 and $9.9 million) match its strategy by mixing stabilized assets with growth-oriented credits and equity investments.
AR Global’s Nontraded REIT Performance
Originally AR Capital, LLC (“ARC”), is a closely held partnership led by Nicholas Schorsch, (with William M. Kahane; Peter M. Budko; Edward M. Weil, Jr; and Brian S. Block). ARC managed American Realty Capital Properties (“ARCP”), a nontraded REIT, and RCS Capital Corporation (“RCAP”) and its subsidiary advisory companies. The company sponsored 15 nontraded REITs, beginning in 2008, raising over $17.5 billion in equity capital through public offerings from 2008 to 2016.
An accounting scandal rocked ARCP in 2014 when it was announced that ARCP’s AFFO had been overstated for fiscal years 2011 through 2013. ARCP’s stock plummeted, costing investors millions, and all officers, including Schorsch, resigned in Q4 2014. Investigations by law enforcement and the SEC resulted in a conviction of Brian Block and penalties of $60 million to Schorsch and ARC to settle SEC charges. ARCP became Vereit in July 2015, and on September 9, 2019, Vereit announced settlements in class action lawsuits related to the accounting scandal that totaled over $1 billion.
During its peak years of raising capital for its nontraded REIT programs, AR Capital (ARC) raised $6.2 billion in 2013 alone, over 31% of $19.8 billion capital raised that year, and $5.4 billion in 2014, over 34% of the industry raise for the year.
Blue Vault’s 5th Edition Nontraded REIT Full-Cycle Performance Study calculated the average shareholder returns to the eight ARC-sponsored REITs that had completed full-liquidity events prior to 2016, with early investors averaging total returns ranging from 14.46% for American Realty Capital Trust III to negative 9.28% for American Realty Capital Global Trust II. Generally, the ARC REITs that had later full-cycle events tended to underperform the earlier events, and underperform their custom benchmarks based upon NCREIF and listed REIT returns matched for asset types and holding periods.
Three additional full-cycle events for ARC REITs have occurred since the 5th Edition Study and their early investor returns are worse yet, from 1.63% for ARC -Retail Centers of America to negative 4.09% for ARC Healthcare Trust III.
There are currently four nontraded REITs originally sponsored by ARC. Benefit Street Partners Realty Trust, a credit REIT, is now advised by a subsidiary of Franklin Templeton. Hospitality Investors Trust has internalized its management and has received a large capital investment from Brookfield. Healthcare Trust and New York City REIT are currently advised by AR Global.
Neither Hospitality Investors Trust nor New York City REIT is currently paying distributions. Benefit Street Partners Realty Trust and Healthcare Trust are paying distributions at the rates of 5.76% and 3.40%, respectively, based upon the original $25.00 share prices. Their most recent per share NAVs have fallen to $18.75 and $17.50, respectively.
Hospitality Investors Trust has seen its NAV per share fall from its original share price of $25.00 to a Q2 2019 NAV of $7.38. Stockholders equity has been eroded by impairments amounting to 3.29%, 3.21% and 11.27% of stockholders’ equity over the last three quarters.
Blue Vault estimates that early investors in the four active REITs that were originally sponsored by ARC have experienced the following annualized returns, using distributions paid and the most recent NAVs in the estimations: Benefit Street Partners Realty Trust 4.19%, Healthcare Trust 0.06%, Hospitality Investors Trust negative 14.44%, and New York City REIT 1.08%.
In summary:
• AR Global, formerly American Realty Capital, has sponsored 15 nontraded REITs and raised over $17.5 billion in equity capital through public offerings from 2008 to 2016.
• Eleven of the nontraded REITs have had full-cycle events and four are still active. Two of the active REITs are self-managed or have new advisors.
• The early investors in the AR Global-sponsored REITs have experienced annualized holding period returns from an estimated 14.63% to negative 9.28% and have, with several exceptions, underperformed custom benchmarks in Blue Vault’s Full-Cycle Performance Studies
• Three additional full-cycle events for ARC-sponsored REITs have occurred since 2017 and estimated annualized early investor returns are low (+1.63%) to negative (-4.09%).
• Hospitality Investors Trust and New York City REIT have eliminated distributions and Healthcare Trust has reduced the distribution rate but still is not covering cash distributions consistently with FFO or MFFO
• Benefit Street Partners, a debt REIT advised by Franklin Templeton, has maintained its distribution rate at 5.76% based upon the $25.00 offering price
