Q&A

According to the Institute of Real Estate Management, professional real estate management is defined as the administrative operation and maintenance of properties to meet the objectives of the properties’ owners. It also involves planning for the future of the properties by proposing physical and fiscal programs that will enhance the value of the real estate.

Professional real estate managers manage a property’s physical site, on-site and off-site personnel, funds and accounts, and leasing activities and tenant services. They’re also called upon to take on asset management functions with responsibility for financial and strategic tasks.

Professional real estate management emerged as a profession the 1930s after lenders foreclosed on thousands of mortgages and discovered that real estate management required specialized skills. 

Commercial real estate (CRE) is broadly defined as any property that can produce income. The most common categories of CRE include office, retail, industrial, medical, hospitality, multi-family, land, and other leasable commercial space.

Debt, as most of us know, means borrowing money to make a purchase. In the world of commercial real estate, debt and financing are standard practices that allow buyers to make large real estate purchases without the need to pay the full price in cash up front from their own accounts. Financing is generally obtained from a bank, insurance company, or other institutional lender to provide funds for the acquisition, development, and operation of a commercial real estate venture. Commercial financing loans are secured primarily by real estate and related assets owned by the borrower.

Operationally, nontraded equity REITs have a lot in common with publicly traded REITs. Both types of REITs use investors’ money to buy properties – such as office, industrial, retail, or hotels – and they lease the buildings to tenants. Rent paid by tenants serves as income for the REIT, and this income is paid out in the form of dividends to investors.

Mortgage (or debt) REITs offer investors the chance to invest in real estate mortgages or mortgage-backed securities. They seek to earn income from the interest on these investments, as well as from the sales of mortgages to other buyers. Mortgage REITs have the same requirement as Equity REITs to distribute at least 90% of their income to their shareholders annually. They can invest in either residential or commercial mortgages.

BDCs – both traded and nontraded – invest primarily in private companies. They are required to invest 70% or more of their assets in U.S.-based private companies. This is an investment type that was previously limited to institutional and wealthy individuals through private equity and private debt funds. Now through these SEC reporting funds, retail investors have access to private equity and debt investments.

Many times, BDCs will invest in smaller or medium-sized businesses. BDCs may be diversified in the industries they invest in or have a specific industry specialization (i.e., energy, technology, healthcare). Additionally, they may focus on equity investments in companies, debt investments in companies or a hybrid of the two. BDCs utilize management teams and advisors to underwrite investments and make loans or equity investments into companies. So far, nontraded BDCs have primarily been focused on investing in the debt side of businesses.

A nontraded REIT advisor acts as its external advisor and manages the REIT’s day-to-day operations and its portfolio of real estate investments, and provides asset-management, marketing, investor relations and other administrative services on the company’s behalf, all subject to the supervision of the company’s board of directors. The advisor is typically a wholly owned subsidiary of the REIT’s sponsor. Some of the REIT’s board members and managers will typically be board members and managers of the REIT’s sponsoring firm.

The sponsor of an alternative investment is an asset management firm that may have many investment vehicles, which can include real estate, private equity, hedge funds, credit funds, BDCs and other investment structures.

Many sponsors of nontraded REITs have introduced several REITs in the past, taking the programs from the IPO to a full-cycle event such as a listing, merger or liquidation. Each REIT will have an external advisor which is a subsidiary of the sponsoring firm, and a board of directors with outside directors who usually serve on the audit committees. There may be considerable duplication of officers, board members and managers across a given sponsor’s nontraded REIT programs.

In accounting terms, a “dividend” is typically a distribution from a corporation’s net income or retained earnings to its shareholders.  Since commercial real estate investments have a unique tax advantage when owned by a REIT, the cash flows from real estate properties usually far exceed its net income as defined by Generally Accepted Accounting Principles or “GAAP.”  This is due to accounting adjustments such as depreciation and amortization which reduce net income while not requiring cash outlays. Blue Vault reports “distributions” to stockholders from the REIT’s cash flows so as to not imply that such cash payments are always from net income.  Distributions are funded from a REIT’s FFO (funds from operations) or MFFO (modified funds from operations) that are adjustments to GAAP net income that take into account depreciation, amortization and other non-recurring items that may reduce net income without reducing cash flows. In the early phases of a REIT’s life, distributions can also be funded in part or in whole from the proceeds of its public offering, until funds from operations are sufficient to fund all distributions.

A REIT is a company formed to use investors’ pooled funds to invest them in properties. In the process, they can qualify for certain tax advantages in the eyes of the IRS. To qualify as a REIT, the company must pay out at least 90% of the money it makes in the form of dividends to the investors.

By avoiding taxation at the corporate level, REITs are able to pass on a greater portion of earnings to investors. This translates into potentially higher yields.

In its broadest terms, a blind pool means that a company is selling stock without specifying how invested money will be spent. In the REIT world, it means that the REIT has begun fundraising by selling shares, but it does not yet own any properties. Investors entering a blind pool do so with the understanding that once enough money is raised, the REIT will invest accordingly in the types of properties identified in its prospectus.

Most nontraded investments state in their prospectuses their targeted timeline for returning investors’ money. The REIT must first go through the distinct phases in its life cycle — emerging, growth, stabilizing, maturing, and liquidating — before it’s in a position to return investors’ money. This process can be long-term — maybe 10 years or more.

Once a REIT has reached the liquidation stage, investors can generally expect to be able to receive cash for their shares in the near future. If the REIT lists on a public exchange, investors can stay invested or they can sell their shares to liquidate their positions. If the REIT sells off its properties and liquidates, then investors can expect a check in the mail for the per-share market value of the REIT’s portfolio less the value of its liabilities (debt).

As with most investments, you’ll receive statements at least quarterly that show how much money you’ve invested in the REIT and how many shares you own. During the initial public offering, nontraded REITs sell their shares at a fixed share price, which is the price that will appear on your statement.

After the initial public offering, some REITs declare a different share value (net asset value per share) and change their offering price as the value of their investment portfolio changes. Some even publish daily adjustments to their net asset values per share and offer to issue or redeem their common shares at these daily prices.

It’s possible that a REIT could adjust the share price shown on your investment statements if it distributes any of your original investment back to you—also known as a “return of capital.”

Nontraded REITs are generally valued by the underlying real estate in their life cycle only after their equity offerings have concluded and independent appraisals have been conducted. It can take several years for the portfolio valuations to reflect the strategy and efforts of the sponsor.

Ideally, the real estate portfolio will command a value that is higher than its original cost, resulting in unrealized gains. In the final years of the nontraded REIT, the valuations of the properties are confirmed by the partial or complete sale of the portfolio, or by listing on an exchange.

The most widely recognized benchmarks for the nontraded REIT industry are available through the National Council of Real Estate Investment Fiduciaries.

Additionally, by becoming a member of Blue Vault, you can access our detailed reports and get sponsor and offering performance information, along with acquisitions and capital raising data.

As with any investment, there is no surefire way of predicting company stability. However, factors such as longevity, track record, previous full-cycle events, and approach to debt could offer clues about a REIT’s stability. Read prospectuses carefully, and discuss any concerns with the asset manager.

• Illiquidity – Once invested, your holdings in a nontraded REIT are generally not available to you until the REIT reaches a liquidity event, although many alts offer redemptions at a fee before then.
• Market risks – Market events and trends can affect real estate performance. For example, a sector such as the hospitality industry may be affected by a decline in the overall economy and a reduction in consumer spending.
• Interest rates
• Variable-rate versus fixed-rate debt
• Hedging variable-rate debt
• Premiums and discounts to NAV
• Economic risks
• Tenant default/creditworthiness – The financial health of any real estate property — whether it’s an office building, hotel, or apartment complex — is dependent upon the entities that lease the property. If a tenant goes into default and cannot pay its rent, the REIT’s income will be affected.

Private Placement offerings under Regulation D of the U.S. Securities and Exchange Commission (SEC) can be conducted using two different exemptions: Rule 506(b) and Rule 506(c). Both exemptions allow companies to raise capital from accredited investors without having to register the offering with the SEC. The key differences are:

• Accredited Investor Verification: Rule 506(b) allows for self-certification by investors, while Rule 506(c) requires verification of accredited investor status. Under Rule 506(c), issuers must take reasonable steps to ensure that all investors are accredited, such as reviewing financial statements, tax returns, or obtaining written confirmation from a third-party verification service.
• General Solicitation and Advertising: Rule 506(b) prohibits general solicitation or advertising to attract investors. Issuers must have a pre-existing relationship with investors before offering the securities. On the other hand, Rule 506(c) permits general solicitation and advertising, allowing issuers to publicly promote the offering through various channels.
• Investor Eligibility: Rule 506(b) allows up to 35 non-accredited investors to participate in the offering, while an unlimited number of accredited investors may participate. Under Rule 506(c), all investors must be verified as accredited, meaning non-accredited investors are not allowed to participate.