Non-Traded REITs are a funny lot. They register with the SEC and comply with all public company filing requirements, yet their shares don’t trade on any public exchange. Most aspire publicly to achieve some sort of “liquidity event” for investors within 7-10 years of formation, either through a public listing or bulk asset sales. Last week, after more than 2 decades, numerous lawsuits and a complicated 3 for 1 reverse split that effectively locks up shareholders for another 12 months, one of the largest Non-Traded REITs in the business finally made the leap to a public listing.
Formerly known as Wells REIT until it was spun out into a new, self-managed entity and renamed in 2007, Piedmont (PDM) sold 12 million shares at $14.50 and began trading on the New York Stock Exchange on the morning of February 10th. The Company had planned to offer 18 million shares at a price of $16-$18.
Piedmont, which owns and manages a 73 property, $4 billion portfolio of office buildings across the country, including trophy properties like the Aon Center in downtown Chicago and the Nestle headquarters in Los Angeles, has a colorful history.
The company was founded in 1997 by Leo Wells and quickly became adept at raising money through a network of independent brokers, paying them commissions of 7% along the way. Wells also earned lucrative acquisition fees for buying property, as well as advisory fees for managing the portfolio. Allegedly, Wells also encouraged investor participation in prayer chains for favorable acquisitions.
This unconventional model attracted the attention of many skeptics, including David Swensen, Yale Endowment’s chief investment officer. Swensen accused Wells of turning a blind eye toward investors’ best interests while he raced to raise money and buy more property. In his book “Unconventional Success” (pages 70-75), Swenson said the high fees simply encouraged two things: the sale of still more shares and the purchase of property – any property – at almost any price:
No rational buyer can compete with the Wells acquisition machine’s willingness to overpay for product. As a consequence, investors suffer the double indignity of high fees and poor investment prospects.
Unfortunately, the Piedmont IPO is confirming Swensen’s claims. Prior to the public listing, Wells orchestrated a 3 for 1 reverse stock split that created four separate classes of shares. Only one class, the Class A shares, now trade on the NYSE, while the rest will convert over time. This effectively delays a full “liquidity event” for another 12 months. The Class A shares traded up to $16 on Friday, but that still translates into a pre-split loss of almost 40%, according to Green Street Advisors.
Even the Wall Street Journal pilloried the IPO. The Journal estimated that investors would have received a “paltry” 2.1% annual return including dividends, assuming the offering priced at the high end of the $18 range. According to an analysis by Green Street Advisors, had those investors simply bought shares in an index of publicly traded real-estate stocks, their total return over that time would have averaged about 8% a year.
Ironically, shareholders had the option of being cashed out in 2007 through a series of buyout offers from Lexington Realty Trust (LXP). Lexington offered to pay up to $9.25 per share (a post-split equivalent of more than $18 per share), but Wells never informed investors of the offers.
Sir Leo argued that the Lexington buyout offers were not material because they were merely tentative expressions of interest. Unfortunately, a federal district court disagreed, stating that “there can be no doubt that this information is material, as it would be considered important by a reasonable shareholder in deciding whether to vote for or against the [spin off].” The court also granted the plaintiff’s request for a class action, and discovery continues.
However, not only did Wells not inform shareholders of the LXP offer, he took the bulk of a $175 million stock payout as a result of the spin off to Piedmont. And when it came time to actually issue himself the stock grant, he lowered the official share price to $8.63, below the $9.25 per share offered by LXP, in order to increase the size of his award.
Certainly, public REITs are imperfect vehicles for a variety of reasons. They are highly correlated to equities, they can be much more volatile than the underlying real estate in which they invest, and they are not great as inflation hedges either. However, beginning at 9:30 every Monday through Friday, excluding holidays, investors in public REITs can vote with their feet and reclaim their money. Sadly, long-suffering Wells shareholders are stuck sucking swamp water for another 12 months before they finally get that freedom. (Update: here’s some information on how to sell non-traded REITs.)