Quest for Safety and Income Drives Capital to Direct Investment Programs

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Investment Tops $10 Billion in 2011 as Traded Markets Languish

...It is no surprise investors are taking increased notice of alternative investments, including DPPs, non-listed REITs and BDCs. Capital raised during 2011 topped $10 billion, up 16 percent from 2010...

As a tepid economic recovery and a faltering European credit situation sustained fears of a double dip U.S. recession and roiled financial markets in 2011, investors did what they always do – flee to safety. But the usual flight paths had hitches. Seeking refuge in the traditional “safe harbor” of Treasury securities meant foregoing any real return on savings. Ditto money markets. Certificates of deposit offered only marginally better returns. Going long on high quality corporate bonds could give a relatively acceptable yield, but the continuing inability of Congress to tackle the deficit and mounting federal debt suggested considerable risk of future inflation and erosion of purchasing power of bond principal.

During the past few years, investors have concluded that a partial shift from financial assets to hard assets was a prudent path. For many investors the decision represents a tactical retreat until the volatility and uncertainty of financial markets stabilize. For others, particularly retirees and pre-retirees, the hostile environment has offered the opportunity to evaluate long-term strategies and to take a page from the playbook of institutional investors, such as pension and endowment funds, which must of necessity, focus on the long term. That page calls for diversification via allocation of a portion of every portfolio to alternative investments.

Increasingly the investment vehicles of choice to accomplish this objective are direct participation programs, or DPPs, non-listed real estate investment trusts (REITs), and non-listed business development companies (BDCs). These are publicly registered companies whose securities offer investors the opportunity to own an interest in a professionally managed portfolio of assets, but which are not listed or traded on the stock market. These companies file financial reports to the Securities and Exchange Commission and observe the same rules of disclosure, transparency and governance as comparable publicly traded securities. DPPs are typically structured as limited partnerships, general partnerships, or limited liability companies; REITs and BDCs are corporations which follow specific regulatory and tax rules to be exempt from corporate taxation. All of these securities are designed to provide attractive levels of current income and the potential for income growth, capital appreciation and inflation protection.

Most classes of direct participation programs and non-listed REITs available today offer the average investor a way to own interests in otherwise non-affordable tangible assets, which tend to respond to broad economic and capital market changes differently than exchange traded stocks. BDCs provide financing to small and mid-sized businesses, and in recent years have sought to capitalize on the relative lack of debt capital in these markets as banks restricted lending to build their capital reserves.

Non-Listed REITs and BDCs Pace Market Growth
With consumer confidence surveys still hovering at less than half their level in 2007, and with the stock market returning only 2.3 percent in 2011 and still down 19.6 percent from its high in October 2007 (as measured by the S&P 500 Index), it is no surprise investors are taking increased notice of alternative investments, including DPPs, non-listed REITs and BDCs. Capital raised during 2011 topped $10 billion, up 16 percent from 2010 and 47 percent from 2009. With no near term awakening from Wall Streets’ slumber in sight and with the expectation that the Fed will continue to keep interest rates near record lows during 2012 to add momentum to the slow recovery, continued strong investor interest in alternatives to stock and bond investing is expected.

Robert A. Stanger & Company, the Shrewsbury N.J.-based investment-banking firm that specializes in the Direct Investment securities markets, credits a significant part of the increase in fundraising to the emergence of non-listed BDCs. “Approximately $1.1 billion of the $1.4 billion increase in overall capital raised in this sector is attributable to the expansion of demand for BDCs this year,” said Keith D. Allaire, managing director of Stanger. The BDC investment thesis is simple and has been compelling: Since many banks have significantly restricted their lending, the supply of funds to growing businesses, particularly middle market and smaller companies, has dwindled. BDCs seek to fill the void and at the same time earn premium yields relative to the risk profile of the businesses they finance.

Investor capital flows to non-listed REITs continued to grow in 2011 (up 3.1 percent at just above $8.3 billion) following a dramatic 36 percent increase in 2010. “While the amount raised this year is below the high water mark of $9.8 billion of new capital reached in 2008, we are confident non-listed REITs will reach and exceed that record level of fundraising in the next few years,” said Kevin Hogan, president and chief executive officer of the Investment Program Association (IPA), the industry trade group for Direct Investments. Kevin Gannon, managing director of Stanger concurs. “The expanding acceptance of asset allocation, the migration of retirement funding from employers to individuals, the focus of retirees and pre-retirees on income-oriented investments, and the appeal of inflation resistant income to active retirees are fundamental drivers of the non-listed REIT industry,” said Gannon. Supporting this belief in a secular shift in portfolio construction by middle income Americans is the fact that non-listed REIT fundraising increased in 2011 despite the reporting of valuations which reflect the declines in real estate values that have occurred following the bursting of the bubble in 2007.

The attractiveness of non-listed REITs is also being enhanced by the positive outlook for real estate investment fundamentals. “While near-term growth is still being constrained by the slow economic recovery, occupancy and rental rate trends are encouraging,” said Martel Day, chairman of the IPA. “The record low cost of debt for real estate buyers and the expectation of attractive acquisition opportunities as hundreds of billions of dollars of CMBS financing come due in the next few years suggest an extraordinary buying opportunity may be at hand.”

The other sector contributing to this year’s fundraising growth was equipment leasing programs, which raised $205 million, up 9.1% from 2010. The driver: Today’s tight credit markets provide the potential for premium returns for the owners of equipment leased to corporate users.

Investment In Publicly Registered DPPs, Non-Listed REITs and BDCs Chart Available in attachment.

Outlook
While most industry participants are bullish on the long-term demand for DPPs, non-listed REITs and BDCs, the timing and extent of that anticipated growth remain a topic of debate within the industry. “Two wildcards which will affect the structure and form of these investments in future years have yet to be turned over,” said Allaire. The first is a pending rule change by the Financial Industry Regulatory Authority (FINRA) which will affect the valuation shown on account statements for these securities during the offering period. The second is the emergence of a new product structure which offers investors enhanced liquidity and daily valuations. “Several of these so-called ‘daily NAV’ products are just commencing fundraising, so the jury is still out on their ultimate success,” said Gannon.

“The industry is on the brink of a sea change made possible by the IRS’ recent allowance in private letter rulings of multiple share classes in REITs,” said Allaire. The ability of non-listed REITs to establish multiple share classes, akin to mutual fund share classes, will enable non-listed REITs to offer securities with different commission structures, thereby potentially lowering front-end fees and expanding avenues of distribution.

Top Fundraisers
Nine of the top ten leading fundraisers in 2011 were real estate sponsors. American Realty Capital Advisors led fundraising with $1.4 billion. Other major real estate fundraisers included Cole Real Estate Investments ($1.3 billion), CBRE Advisors ($658 million), W.P. Carey ($630 million), and Behringer Harvard ($617 million). (See table in attachment.)

The second largest fundraiser in 2011 was Franklin Square Capital Partners, with over $1.3 billion raised. The company launched the industry’s first non-listed business development corporation to be sold through the independent broker dealer network late in 2008, and the rapid acceptance of this product by broker-dealers, financial advisors, and investors has prompted several other advisory firms to form and offer BDC investment products.    

Top 10 Public Program Sponsors Ranked By 2011 Capital Raised Chart available in attachment.

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Robert A. Stanger & Co., Inc. founded in 1978, is an investment banking firm specializing in direct participation program securities. The Company is regularly involved in real estate mergers and acquisitions, debt and equity financings, real estate appraisals and securities valuations. Stanger & Co., Inc. is also the publisher of The Stanger Report, a newsletter focused on the direct investment industry.

The Investment Program Association (IPA) provides the direct participation program and non-listed REIT industry with national leadership in the public interest and serves as a progressive resource advocating Direct Investments (including non-listed REITs, equipment leasing, oil and gas and business development corporation programs) as an important part of a diversified portfolio. Learn more about becoming a member.

For More Information:
Robert A. Stanger & Co., Inc. Contact: Keith D. Allaire | Managing Director | (732) 389-3600

IPA Media Contact: Roxanne Pipitone | Gibbs & Soell, Inc.| 312-648-6700, ext. 2112| rpipitone(at)gibbs-soell(dot)com

IPA Contact: Kevin M. Hogan | President & CEO | 212-812-5799| khogan(at)ipa(dot)com

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Roxanne Pipitone
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