Using Reverse Mergers as a Liquidity Tool for Non-Traded REITs

“Till death do you part” could be the mantra of most non-traded REITs. Most non-traded Real Estate Investment Trusts (REITs) have a built-in self-destruct of between five and …

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“Till death do you part” could be the mantra of most non-traded REITs. Most non-traded Real Estate Investment Trusts (REITs) have a built-in self-destruct of between five and ten years. Thus, the natural course of most non-traded REITs forces a liquidity event. At that juncture, the options available include an IPO or its less-costly alternative, the reverse merger.  Nuances between both traded and non-traded REITs, recent returns in the REIT market, the size of the REIT, the cost of structuring a liquid exit and the shelf-life of the REIT all factor into how shareholders might be inclined to exit a non-traded REIT.

Traded vs. Non-Traded REITs

Both traded and non-traded REITs are special real estate investment vehicles. The typical REIT is an entity not subject to tax with the stipulation that 90% of the annual profits from the REIT are returned to shareholders. Such profits are subsequently taxed at individual shareholder rates. The benefits of REITs are a phenomenal asset class to be included in any truly diversified investment portfolio. The lack of liquidity, lower returns, five to ten year lock-up, high fees and obscure transparency of non-traded REITs has made them an asset class to be avoided, at least by the more scrupulous investment advisors.

I tend to agree with many of the negative components inherent in non-traded REITs. Having said that, it doesn’t mean that advisors will stop promoting or that non-traded REITs will cease to exist as an asset class. Quite to the contrary. By their very nature, non-traded REITs create a good windfall for the promoters, earning them higher fees than traditional REITs and locking-up capital for unnecessary length. In fact, Blue Vault Partners released a study showing the IRR of non-traded REITs was significantly lower than their more liquid public counterparts. Thus, getting out of a private REIT sooner rather than later is preferable.  

REITs Since 2008

The downsides of non-traded REITs have been slightly obscured by the recent boom in the REIT market overall. Low asset valuations since the market plunge in 2008 have helped to fuel the emergence of both traded and non-traded REITS alike. In fact, most REITs have outpaced the returns projected by most analysts in recent years. With the market returning to its former glory, many non-traded REITs have taken advantage of various liquidity options for exiting their investments.

Both traded and non-traded REITs are not the only asset classes to have done better than analysts expected. It’s tough not to have wild increases over expectations when nearly all asset valuations started at such unprecedented lows after the crisis. Couple that fact with the Fed’s $85 billion a month stimulus and it’s the perfect combination for above-expected asset returns. If it just so happens you made said returns in your non-traded REIT, then great. The question still remains: “how are you going to exit the investment?”   

Gaining Liquidity: IPO vs. Alternatives

When it comes time to part with a REIT, there are a number of options available. First, REIT shareholders can opt for a traditional IPO, including the full dog and pony show from investment bankers and market-makers. This process, while high profile, is ultimately the most expensive option and not always the right fit, especially for REITs whose assets may dip below the $1 billion mark. Secondly, an non-traded REIT can “go public” with an existing public REIT, regardless of the difference in size. Such a reverse merger creates a combined REIT with greater assets and enhanced growth options for both the shareholders of the acquirer and the target. These types of deals can occur on any number of the major exchanges including the OTC, NYSE or NASDAQ.  Finally, some REITs opt for using smaller public shell companies to get their shares traded and obtain a liquidity event. The last option includes the least amount of fanfare, but can save significant time and money in the “go public” process.

Certainly, non-public REITs are not without their inherent risks and critics– and rightfully so. It doesn’t mean they are going away anytime soon. Furthermore, most of the risks and downside such REITs incur are–at least in part–due to the lack of inherent liquidity in the investment. Solving liquidity is as simple as performing a reverse merger into a shell or an existing public REIT on any of the major stock exchanges. Regardless of whether you were sold a bill of goods when you bought into the private REIT, there is still time to make at least a positive return once the REIT begins trading in the public markets.

 

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