Single-Tenant REIT Ride Ending for Schorsch’s AR Capital
Nicholas Schorsch, who in seven years built the top company in the $10 billion industry of nonlisted U.S. real estate investment trusts, is leaving behind the types of properties that made the firm No. 1.
Schorsch’s New York-based AR Capital LLC is switching its focus to nontraded REITs that buy properties ranging from health-care facilities to Manhattan office buildings. He’s dropping his longtime strategy of starting companies that buy single-tenant buildings, also known as net-lease firms, after forming five of the them.
Publicly traded REITs that own single-tenant buildings are currently able to raise money more cheaply than nonlisted landlords because stock-market demand places a premium on their shares. Schorsch, who has accumulated thousands of buildings that house drugstores to restaurant chains, said nontraded REITs will be at an even bigger disadvantage as rising interest rates increase borrowing costs, narrowing the spread to make money.
“That cycle is starting to wane,” Schorsch, in a telephone interview, said of nontraded single-tenant REITs. “Right now it’s a great opportunity. Net lease is fabulous and spreads are great, but a year from now, as the economy recovers we need to be in a more growth-oriented side of the business.”
Schorsch’s retreat from new single-tenant nonlisted REITs is a sharp shift for the business he has been building since 2006 and turned into a real estate empire. AR Capital has raised $4 billion this year through June, according to investment bank Robert A. Stanger & Co., the most of any nontraded REIT company.
The industry, which mostly caters to individual investors who buy shares through brokers, attracted a record $10.7 billion in the first half after raising about $10.3 billion last year, according to the Investment Program Association, citing data from Shrewsbury, New Jersey-based Robert A. Stanger.
“They’re No. 1 in the space by a wide margin,” Kevin Gannon, president and managing director at Robert A. Stanger, said of AR Capital. “They’re probably feeling like they have saturated their book a little bit with net-lease nontraded product.”
Single-tenant landlords make money on the spread between their cost of borrowing or raising equity and the yield, or capitalization rate, on the property they buy. Cap rates are net operating income divided by purchase price.
Low interest rates have been a boon for the companies because the cost of borrowing is low compared with returns on buying property. Shares of single-tenant landlords -- sometimes known as net-lease or triple-net because the tenant is responsible for costs relating to the property, such as taxes, in addition to the rent -- have gained 32 percent in the past two years, more than the 25 percent gain in the broader Bloomberg REIT Index.
The rally has pushed shares of public companies to a premium over their net asset value, making raising capital by selling equity less expensive, said Jim Sullivan, a managing director at Green Street Advisors Inc., a Newport Beach, California-based real estate research firm. Nontraded REITs sell equity at net asset value, Sullivan said.
“Right now the public market is according the triple-net companies a cheaper cost of capital,” Sullivan said.
Schorsch, 52, will still be a force in the single-tenant business through the publicly traded American Realty Capital Properties Inc. (ARCP), of which he is chairman and chief executive officer. That company, which went public in September 2011, has grown from $83 million in market value at the start of last year to about $2.5 billion now.
American Realty Capital Properties has expanded through acquisitions and has plans to complete $1.1 billion of deals in the second half of the year, including a $416.5 million purchase announced last week. It is growing in part by acquiring REITs that AR Capital sponsors. It purchased American Realty Capital Trust III Inc. in February for more than $2 billion in cash and stock and also plans to buy American Realty Capital Trust IV in a deal it values at $3.1 billion.
American Realty Capital Properties will be the second-biggest single-tenant landlord after it completes pending deals, including its planned acquisition of CapLease Inc. (LSE) for $755 million. The largest net-lease company is Realty Income Corp. (O), based in Escondido, California, which has a market value of more than $8 billion.
The industry has been among the most active this year for mergers and acquisitions. In addition to American Realty Capital’s deals, W.P. Carey Inc. (WPC), an owner of single-tenant buildings and a sponsor of nonlisted real estate investment trusts, agreed on July 25 to buy one of the companies it manages in a deal valued at about $2.4 billion.
Sullivan expects such transactions to continue because of the amount of nontraded REITs in the business that will need to list their shares on stock exchanges or merge with another company as the end of their investment life approaches. Nontraded REITs eventually have to return shareholders’ investments after a set amount of time.
“There’s going to be a lot more M&A activity,” he said.
American Realty Capital Properties is managed by AR Capital, which receives some fees related to the company’s operations, including acquisition fees. Base management fees were waived in the second quarter, according to the REIT’s latest quarterly report. The company’s board is considering internalizing the management, Schorsch said.
Schorsch said the bulk of fees, including asset-management fees, to manage the nontraded REITs through closely held AR Capital are contingent on investors getting the opportunity to get their money back, such as through a public offering or a sale of the company.
“Unless we create a successful liquidity event, those fees are all waived,” he said. “We put ourselves in harm’s way.”
American Realty Capital Properties has gained 1.4 percent this year, compared with a 4.7 percent increase in the Bloomberg single-tenant REIT index. The gauge has tumbled 21 percent from a May 21 high as interest rates climbed, fueled by expectations that the Federal Reserve will scale back the pace of its stimulus plan as the economy rebounds.
“Net lease does very well in a volatile economy,” Schorsch said. “A year from now when this economy has a 4 percent growth rate, when cap rates are compressing in that space, is that the right time to be buying? I say no.”
Schorsch said at an investor day for American Realty Capital Properties on July 24 that the ARCT V REIT will be the last net-lease program “for a number of years to come.” The company’s nontraded net-lease business will pause through all of 2014 and potentially all of 2015 “if not forever,” he said.
“We came to the conclusion that the cost of capital advantage toward the public companies is continuing to migrate and that the private companies will not be able to be competitive in the space,” Schorsch said at the investor day.
AR Capital now has REITs for global single-tenant buildings and one focused on New York commercial real estate that are in the early stages of their lives. The company also has health-care, shopping center and commercial real estate debt REITs among their offerings.
“We have other programs that raise a lot of money,” Schorsch said.
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