Heller, who brought many REITs public between 1987 and 2000 while working on Wall Street, is less actively using publicly traded REITs given their current valuation levels. “Should there be a decline in the public REIT market,” he says, “we would feel comfortable stepping in knowing that the net asset value of the underlying entities would be terrific support in limiting our downside while collecting a compelling dividend.”
Building A Better Mousetrap
NAV REITs are “an exciting corner of the market,” says Ettore Santucci, co-chair of the REITs and Real Estate M&A group at law firm Goodwin Procter LLP and one of the Goodwin partners who developed the NAV REIT structure circa 2003. Still, he sees room for improvement in these products—particularly with regard to liquidity.
NAV REITs are more liquid than traditional non-traded REITs, but their aggregate redemptions by shareholders are typically limited to 5% of net asset value per calendar quarter or 20% per year.
“When people get stressed, they clamor for a limited amount of liquidity,” says Santucci. NAV REIT provisions about gating or queuing redemptions may not be enough to control outflows. David Roberts, a partner and member of the REITs practice at Goodwin Procter, also points out that NAV REIT investors who don’t need immediate access to liquidity are still paying for it through lower dividend yields. “Everybody is in the same boat,” says Roberts.
Santucci, Roberts and their colleagues are proposing to their clients a split-class arrangement for NAV REITs that would provide higher dividend yields for less liquid share classes and lower dividend yields for more liquid share classes. They think this arrangement (which they say is not currently available with NAV REIT offerings) could control a bit of the redemption risk and reduce the need for NAV REITs to sell off assets.
“The split class is effectively nothing other than a way to build a toll highway and a freeway,” says Santucci, who notes that financial advisors could match clients’ duration and risk profiles to the subclass best suited to the clients’ needs.
Advisors should disclose redemption features to clients, says Gannon, but so far redemptions haven’t been a big issue with most of the REITs. Still, “You shouldn’t be jumping in and out of real estate,” he says. “If you have a horizon in your mind of seven to 10 years, real estate is a good place to invest money.”