The direct investment industry could see a changing of the guard as the dominant firms controlled by non-traded REIT magnate Nicholas Schorsch continue to suffer a crisis of confidence.
Competing sponsors of direct investment programs will likely pick up some market share from Cole Real Estate Investments and American Realty Capital programs as some advisors pull back from those Schorsch-affiliated products.
Cole and ARC now dominate the market, with about a 50 percent market share.
A number of broker-dealers have temporarily suspended sales of programs affiliated with the Schorsch firms in light of the $23 million accounting error disclosed by American Realty Capital Properties at the end of October.
Schorsch is an ARCP board member and chief executive of ARC. ARCP, the publicly traded REIT, owns Cole.
The bad news for the Schorsch firms, though, could be good news for competitors.
“Competing sponsors are indicating that their respective fundraising is accelerating modestly in light of the ARC/Cole matters,” Kevin Gannon, managing director at Robert A. Stanger & Co. Inc., said in an email.
Stanger tracks the direct placement industry.
“We expect substantial downdrafts in ARC and Cole fundraising in the near term,” Gannon said.
One source at a competing sponsor, who asked not to be identified, said his company’s sales were up about 20 percent so far in November, although this source was unsure whether the uptick was due to problems at ARCP.
“People want to be diversified in commercial real estate, and would look elsewhere” if they can’t access ARC or Cole products, said Kevin Hogan, chief executive of the Investment Program Association, which represents product sponsors.
RCS Capital Corp. (RCAP), the Schorsch-affiliated broker-dealer and the dealer-manager for ARC products, has taken a hit. On a November 13 earnings call, RCAP officials declined to give future guidance for the direct-investments wholesaling business due to the disruptions caused by ARCP’s problems.
Officials at ARCP and ARC were not available for comment.
What the long-term impact on the non-traded REIT market will be is hard to predict, said Keith Allaire, also a managing director at Stanger.
“If there is a continual flow of issues, it will have a significant impact, simply because [ARC and Cole] represent about 50 percent of the entire market,” Allaire said.
Direct-investment providers need the trust of investors and advisors to gather money and deploy it in what is essentially a blind pool. The ARCP situation could hurt perceptions of the entire industry.
“What we may see out of this is more focus on operating controls at the sponsor level,” said Scott Smith, chief executive of FactRight LLC, a due diligence consultant for the industry.
Many advisors have gotten used to seeing money in non-traded REITs turn over every few years––generating both new commissions and happy investors, observers say. Those days may be gone, especially if Schorsch has to cool his buyout activity.
Even prior to the ARCP accounting fiasco, sales of non-traded REITs and other products were already slowing from 2013’s liquidity event-driven record pace.
Year-to-date through October, sales of non-traded REITs, which account for three-quarters of the direct investment industry, were off 20 percent compared to the same period a year ago. In 2013, REIT sales were up 89.5 percent, according to Stanger.
The ARCP issue “is certainly not going to have a positive effect” on sales, Allaire said. “It will be tearing [the Schorsch companies] apart for awhile.”
But Hogan from the IPA remains upbeat.
“Despite everything that’s happened with ARC and its affiliates, nothing in the industry has really changed,” he said. “The non-listed REIT industry continues to have strong fundamentals.”
Hogan said a pending rule from Finra that will require per share estimated values on statements is spurring product improvements, such as daily NAV products and new share classes with level loads.
“I think that’s going to play very well for investors,” he said.