Real Estate Alts Navigate Choppy Waters
Non-traded REITs and other private real estate investment alternatives have slammed headlong into some significant market challenges of late with higher interest rates and uncertain property valuations that have triggered a run of redemption requests. The sector also is facing new regulatory reforms, which if approved, could create additional fundraising hurdles for sponsors.
On the positive side, the space is continuing to grow with new entrants and new products aimed at capturing a bigger piece of the retail investor market. The latest industry fundraising data from Robert A. Stanger & Co. also holds good news. Total fundraising for alternative assets during the first quarter reached $16.2 billion. Despite continued pressure from redemption requests, non-traded REITs posted net positive fundraising for the quarter with $6.3 billion in new fundraising compared to $4.6 billion in redemption activity.
WMRE recently talked with Anya Coverman, president and CEO of the Institute for Portfolio Alternatives (IPA) to hear more about how the sector is managing challenges, where there are opportunities for growth, and how the industry is continuing to evolve to better meet the needs of retail investors and financial advisors. The IPA represents members who are active in Lifecycle REITs, net asset value (NAV) REITs, business development companies (BDCs), interval funds, closed-end funds and direct participation programs (DPPs).
This interview has been edited for style, length and clarity.
WMRE: Are you seeing any particular trends in the expansion of certain types of private vehicles?
Anya Coverman: We are definitely seeing ideas around new product innovation around, “How do we structure a REIT?” In fact, three big new entrants came to the market, and the REITs were structured in three totally different ways. We’re also seeing more niche products, such as renewable infrastructure and ESG. How are we creating something sector-focused and new and different? I don’t know where that’s all going to land, but I think it’s going to be great in the sense that it offers investors and the advisors that represent them opportunities for different choices.
Over the last few years we have seen a 721 UPREIT from a DST transaction. We’re also seeing sponsors looking at a private REIT or private BDC. Some of the reasons are because of regulatory uncertainty and for others it is just product innovation, or what type of product their distribution partner might be looking for.
The other trend is that the sector is expanding to include more household names. We have household names that have been in the public REIT market for a long time and have a real ownership share in the market, and now they are looking at the non-traded side. We’ve also seen large RIAs that have stood up an interval fund, for example. So, it’s very exciting to see where this expansion will lead.
WMRE: Are you seeing retail investors that are interested in expanding their allocations to private real estate vehicles?
Anya Coverman: If you look at the institutional investor space, we’ve seen trends from 5% to 12% in the use of alternatives. From a retail standpoint, we’re still at about 1%. So, there is so much opportunity for growth. In this time of economic volatility, it’s a great time for innovation, and it’s a great time to take advantage of alts and have that diversification.
For a large majority within our membership, accredited investors are the ones purchasing these products. There are some limitations around how you can solicit participants in your product. However, there is some uncertainty there. We are in a period of divided Congress. What that leads to is a lot of activity on the regulatory level. For example, we know the accredited investor definition is going to be revisited.
WMRE: From a high level view, what’s the regulatory landscape like for some of these private alts structures? Is it starting to tighten, or is it more that there is always something happening on the regulatory front?
Anya Coverman: My personal view is that there is always something. People can get caught up in the most recent regulatory challenge, but there is no highly regulated product that is not going to have challenges come and go, and sometimes you see regulatory challenges depending on the political environment. When there is a divided Congress, it is usually quieter on the legislative front, and you see a more active regulatory environment. That is nothing new. There is a normal flow of balancing capital formation with investor protection.
WMRE: What are some of the key regulatory issues the industry is facing right now?
Anya Coverman: We know that on the SEC’s short-term regulatory agenda is revisiting the accredited investor definition. The Current SEC is very likely to limit who will qualify as an accredited investor. The House Financial Services Committee just passed a large packet of bills. They are reading the tea leaves and put forth a number of proposals, many of which passed on a bipartisan basis, that would expand the accredited investor definition in what are pretty thoughtful ways that also promote investor protection. So, that is going to be very hot this year. We’re going to see a lot of activity between the SEC and Congress.
Another issue that the (non-listed) REITs and BDCs are focused on right now is a statement of policy on non-traded REITs that NASAA, the organization that represents state regulators, proposed last summer. Those REIT guidelines would have pretty severe restrictions on the ability of investors to be able to purchase non-traded REITs, and it also extends to non-traded BDCs as well. NASAA is already talking about future guidelines. What a lot of people are worried about is a concentration limit, essentially telling investors what their concentration limit can be in purchasing these products without any type of carve out for an accredited investor or other type of investor. We have heard that NASAA is considering some changes after receiving public comment letters, but they have kept it pretty close to the vest on what those changes might look like.
There are already concentration limits. So, this is not creating something that doesn’t exist, but it is expanding what they could look like and what investors’ options would be. With the uncertain movements from federal and state regulators, that’s where you see sponsors looking at: What products are we designing? What are those products going to look like? And what does the regulatory landscape look like?
WMRE: What are the current NASAA concentration limits, or do they vary?
Anya Coverman: It varies by state. Any issuer has to put that in their prospectus and list out the 20 or fewer states that have concentration limits. Our concern is that NASAA is proposing a uniform proposal that would be a lot stricter than what we’ve seen in many of the states. Their goal is for this to be uniform across all the states. Ultimately, these are national offerings that are sold by national distributors. And to have a patchwork of different concentration limits is difficult if not impossible for the distribution channel to comply with, so they adhere to what the most restrictive standard is across the country.
The bigger question for us is why are non-traded REITs being singled out in this way? There is no other registered investment product that contains restrictions on how much you can invest in a product or an industry. So, to adopt this and argue there is a need for concentration limits is a concern. The NASAA proposal doesn’t point to any evidence of harm, or any evidence of justifying a need for this.
WMRE: How would greater concentration limits impact the industry?
Anya Coverman: Ultimately, concentration is exactly that. It is a limit on a concentration of an investor’s liquid net worth. That is kind of a novel piece that doesn’t exist under federal securities laws. It would affect non-traded REITs and affiliates of the issuer for other direct participation programs. That is a pretty sweeping limit, and there is no exclusion if you were an accredited investor, for example. The accredited investor exclusion is something that we have argued for very strongly. So, while there have been concentration limits, which ultimately limits purchases in the industry, this would be just a more expansive proposal. And it is expansive at a time where investors are asking for access to alternatives and asking for diversification.
WMRE: Do you think part of this is triggered by the redemption requests we have seen over the last several months?
Anya Coverman: No. This was something that was initiated last summer before we had these redemption requests. While today NASAA may point to that, the redemption requests are a perfect test of features to model the liquidity that has been stated in the prospectus and fully disclosed to investors and one that the sponsors in our space have passed. It is remarkable that these are a less liquid real estate product that also provides this level of liquidity to investors, and they were designed that way. This is a great test case for meeting redemptions as designed in the product features.
WMRE: How do you think non-traded REITs are positioned to handle a longer run of redemption requests, possibly into 2024?
Anya Coverman: They have built significant liquidity sleeves. They also can go to the market and liquidate assets. So, from my view, if the runway of redemption requests extends through the end of this year, that is something the firms are capable of handling. We don’t know the future of the market, and I can’t predict what 2024 and 2025 will look like, but there is an expectation that at some point markets will begin to stabilize.
WMRE: Obviously, there are a lot of near-term challenges, how do you think the industry of private real estate investment alternatives is positioned for growth in the longer term?
Anya Coverman: One of the trends that we’re seeing is cross pollination where a lot of asset managers are looking at offering a whole host of different products. They realize that there are different distribution channels and investors like different options. They might want to consider an interval fund, a non-traded REIT or perhaps a private REIT. They may want to have a DST program or a 721 UPREIT transaction.
While the industry has household names and has had so much growth, we are really at a nascent stage in terms of opportunities for alternatives in the retail channel. In some ways, it is really at an early stage of where growth can happen. The products that we have today are great, and they are designed well. But I think you will continue to see more innovation and continuous evolution and this cross-pollination with firms that want to have numerous products on the shelf to meet the needs of advisors and investors.
WMRE: We have seen big name players enter the space with Blackstone, Cantor Fitzgerald, JP Morgan and others. Do you expect more new entrants?
Anya Coverman: Yes, Cohen & Steers is now in the non-traded REIT space as well. That is a very interesting note, because they are a huge player in the traded REIT space. For them to show an interest and be moving into the non-traded space is really reflective of the fact that this is still a growing market. You also have Prudential and PIMCO, and structures that might include a NAV REIT, a tender offer fund or an interval fund. The names surprise me every day.
WMRE: So, is the overall market or pie getting bigger as well, or do you think the new entrants and new products will create more competitive pressure?
Anya Coverman: The pie is getting bigger, but there will always be competitive pressures. There are many firms that are looking to compete with Blackstone, but I still think the opportunities for market share are growing.
WMRE: Are there any other key issues that the industry or the IPA is focused on that you would like to highlight?
Anya Coverman: One of the issues that we’re focused on is the need for more education. An interesting statistic is that 60 to 65 percent of sales are in no load shares. That activity speaks to the opportunity in the advisor channel and a need for more education around the product, the product design, how this product fits into a portfolio, diversification, redemption features and other issues. So, education is definitely a big topic for us.