Stroock & Stroock & Lavan’s Evan Hudson on Non-Traded REITs and Mini-Tender Bidders
By Matt Grossman October 12, 2018 9:00 am
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For years, investors in real estate investment trusts (REITs) were largely forced to pick their poison. On the one hand, those who prize liquidity could invest in market-traded REITs that are easy to sell off in a pinch, but these trusts have, in recent history, traded at a discount to their underlying net asset values. On the other hand, some investors preferred non-traded products that are firmly pegged to appraisals of the underlying property—but it was no simple matter to slough off these shares at a moment’s notice if you unexpectedly need some cash.
Facilitating liquidity in the non-traded REIT market has in part fallen to an aggressive set of discount-hunters called mini-tender bidders, who offer to buy non-traded shares from REIT investors at steep markdowns. Like pushy consumer lenders, they often solicit business with mailers or other sales campaigns hoping to find REIT investors seeking emergency short-term liquidity.
In a world in which non-traded REIT investors were locked in for the long haul, these bidders turned a brisk trade. But with more institutional sponsors backing non-traded REITs that feature easier liquidity than ever before, will mini-tender shops find themselves backed into a corner? Commercial Observer called up Evan Hudson, a New York-based lawyer at Stroock & Stroock & Lavan and an expert on the fine print that makes REITs tick, to find out.
Commercial Observer: What role has liquidity played in shaping the non-traded REIT sector in the past?
Evan Hudson: In the public, non-traded REIT sector, for many years, liquidity was just not a defining feature. They were life-cycle REITs that had a beginning, a middle and an end. The end was when they would merge, or list or sell all their assets. Until then, stockholders were just kind of stuck. There was a redemption program, but it could be waived. The intent was, you keep your money in the liquid product, and you get your money back after the liquidity event. Meanwhile, what happens when the sponsor just takes a long time to return the capital?
Have there typically been parameters that require them to stick to a schedule?
Most charters didn’t say that the money has to be returned by a fixed date. It wasn’t usually that concrete. There was a lot of flexibility, so sponsors would often keep the capital locked up. It was often jokingly called “The Hotel California.” You can never leave.
And that’s where mini-tender bidders come into play?
Right. This is what created a market opportunity for the mini-tender bidders. These are people who come in either with their own money or through raising their own funds, and they offer to buy shareholders’ illiquid shares at a steep discount to net asset value—simply because shareholders are desperate to get out sometimes. If there’s no liquidity in sight, you can pick up shares for a song. That opportunity’s just too good to pass up for some people. The practice is highly, highly annoying to sponsors, and the [mini-tender] industry does not always have a good name. But it’s perfectly legal, and everything’s transparent.
Mini-tender bidders: are they specialty firms, or do they do other work too?
Both. Usually, they come in two flavors. There’s one type of player that you see that invests in real estate securities generally, or real estate generally, and does mini-tender offers as part of a larger real estate allocation for its clients. Then there are sharper individuals who really focus on mini-tender offers, whether they’re for corporates or real estate or whatever else.
You said this whole thing really annoys REITs. It’s all in the secondary market, though, so why does it bother them?
The bidder is able to outsource some of its [transaction] costs to the REIT. The REIT has to respond to the bid by law, with a recommendation to stockholders that they either tender their shares or that they don’t, or that the board is making no recommendation. Just by having a mini-tender offer out there—when someone comes along and says, the net asset value is $8 per share, and we’re bidding at $3 per share—they have to respond. It’s a simple thing to make that offer, but the REIT has to go into fire-drill mode. They have to go into a board meeting, or get all the directors to sign a written consent with a recommendation, and possibly file [securities paperwork]. There’s securities liability anytime you make a filing. It’s actually usually very costly to sponsors.
And how big a universe is this?
There are several mini-tender offers per month, industry-wide. REITs have always complained about this industry—I mean vociferously complained. But now a lot of REITs seem to be solving their own problem by providing liquidity.
What are some of the reasons investors are sometimes interested in selling their shares at such a discount?
There’s the really unsympathetic answer, which is that an investor might not understand the offer and not understand that it’s a below-market bid. I think that’s sort of a worst-case scenario that’s not that common. I think the more common narrative is just that someone needs money and they can’t wait for a liquidity event. Maybe they’re an elderly person who needs funds to go into a nursing home, or a parent paying college tuition.
Who’s the typical non-traded REIT investor, anyway?
The typical non-traded REIT investor is what we call the “mass affluent.” That means the smaller end of accredited investors, and individuals who are not accredited investors but who nevertheless do meet some kind of income and asset threshold. It’s not just anyone: there’s a level of affluence involved.
Do investors ever just sell their shares to mini-tender bidders because they don’t like the direction the REIT is taking, and their confidence in the business model is getting shaky?
It’s sort of the opposite of that. Mini-tender bidders are not going to buy shares in what they think is a sinking ship. The fact that they’re scooping up the shares is by definition a vote of confidence in management and a symbol that management is doing something right.
Do non-traded REIT investors have any alternative to these bidders if they want to get out early?
Other than surrendering your shares at a ridiculous discount, your best bet is to go to what is a very small and thinly traded market that is out there. Illiquid shares always sell on this market for a discount, but it’s not quite as steep as the discount mini-tenders offer. Part of it is the ease of transaction. Mini-tender is a passive thing. You just get solicited to sell your shares, and it’s very easy. Someone just sends you the paperwork. When someone comes along and says, “Here’s cash money for your shares, just send in your paperwork,” that’s a really easy proposition.
How do you see the dynamics of mini-tender offers changing?
There’s been this idea for a long, long time that non-traded REITs need to provide some liquidity. It’s such an obvious idea, and sponsors have been trying for so long to provide liquidity [while maintaining] net asset value. It’s a very old idea. There have been net asset value REITs for a long time, but in 2016 and 2017, a bunch of new sponsors come on the scene and said, “Look, we’re offering non-traded REITs, but they’re better because they have liquidity at NAV!” And then everyone was like, “Liquidity at NAV! I’ve never seen that before!” At some point there’s a tipping point. Enough investors get the idea and it just kind of takes off.
How will greater availability of liquid net asset value REITs affect the mini-tender world?
If the non-traded REIT industry becomes much more liquid over the next decade, people who are accustomed to scooping up illiquid shares at a ridiculous discount will have to look elsewhere for the same arbitrage opportunity. They might start looking more at private placements and limited partnerships. The mini-tender industry might just go to ground and do more deals in the private space, where, as far as I can see, the opportunities will still exist.
