The Evolving Landscape of Non-Traded REITs - Featuring a Discussion with Hines and KKR
Introduction
A non-traded REIT (NTR) is a private real estate investment vehicle that provides Investors with access to a diversified portfolio of institutional-quality real estate properties and/or loans. NTRs and other semi-liquid fund formats have structural features designed to address a number of the pain points that have historically limited Investors’ entry in private real estate. Today, the NTR space continues to attract capital from various Investor channels. In the last five years, many new entrants in the space created a more competitive environment with Investor-friendly terms, while providing access to high-quality, income-producing real estate with long-term appreciation potential. In our latest blog, we explore the evolution of the NTR and semi-liquid real estate fund space, how the current market environment may impact these vehicles and a discussion with industry experts.
We want to thank Hines, KKR and Robert A. Stanger & Company, Inc., for their contributions to this article, given their extensive knowledge of the NTR space. Hines Interests Limited Partnership (Hines) is the sponsor of Hines Global Income Trust, Inc., an NTR comprised of 38 assets with a total gross asset value of $3.9 billion and net asset value of $2.7 billion as of November 30, 2022. KKR Registered Advisor LLC is the investment adviser of KKR Real Estate Select Trust Inc. (“KREST”), a REIT registered under the Investment Company Act of 1940, as amended (’40-Act REIT), comprising investments in 44 properties and 18 real estate credit positions with a total gross asset value of $3.5 billion and net asset value of $1.6 billion as of November 30, 2022. Robert A. Stanger & Company, Inc., is an investment banking firm with expertise in real estate, real estate securities and alternative investment products, including non-listed REITs, business development companies (BDCs), direct participation programs and interval funds.
The Evolution of Non-Traded REITs
NTRs were initially introduced to the market in the 1990s and have evolved over time. The early NTRs had restrictive limitations on liquidity and higher fees. Their shares were offered at a fixed price for the duration of a continuous offering (typically 2 to 3 years), often an arbitrary $10 or $20 per share, whether an Investor bought on the first day or last day of the continuous offering period.[1] Redemptions were capped at up to 5% of the weighted average number of shares outstanding during the previous year. NTRs were considered closed-end vehicles with a finite life, generally of up to seven to ten years, at which point an exit strategy was expected to be initiated, which could take the form of a merger with a publicly traded REIT, a full liquidation or a listing on an exchange as a publicly traded REIT.
When these early NTRs were originally introduced, they were marketed to Investors with upfront selling commissions close to 7% or higher, along with broker fees ranging from 2-3%. As a result, only around 90% of an Investor’s capital was invested in the portfolio of real estate, as about 10% was immediately paid out for these commissions and fees.
The NTR space started to become more institutionalized with the introduction of the Net Asset Value (NAV) REIT in the early 2000s. The NAV REIT was designed to be more Investor-friendly, including more frequent valuations, increased opportunities for liquidity, an open-end structure and lower fee loads relative to the original iterations of the NTR from the 1990s. In recent years, the NAV REIT structure has evolved considerably since its formation in the early 2000s, though it still comprises of the core features noted above. The market has also seen variations in investment strategies and fund structures emerge, as more sponsors continue to enter the space. For example, the introduction of the ’40-Act REIT, a structure that is regulated by the SEC under the 40 Act, has emerged.
Sponsors of today’s NTRs, such as Hines, KKR, Blackstone, Starwood and Ares, are offering products with structures that aim to be more Investor-friendly, with features such as lower fees, greater transparency and improved accessibility. Given these structural improvements and ability to access some of the benefits of private real estate exposure, including the potential for tax-efficient income, long-term appreciation and portfolio diversification benefits, the semi-liquid fund space has re-emerged with renewed popularity over the last several years. According to data from Robert A. Stanger & Co., NTRs raised a record high of $36.5 billion of capital in 2021. NTRs raised $30.5 billion through October 31, 2022, up from $26.6 billion for the same period of 2021. The chart below exhibits year-to-date 2022 fundraising totals for the top NTR Sponsors as of October 31, 2022.
Common Features of NTRs
NTRs allow Investors to subscribe at NAV, typically on a monthly or daily basis. Unlike drawdown funds, an Investor’s capital is fully invested as soon as their subscription is processed and accepted.
Most NTRs have redemption programs to allow Investors to get out of the investment through periodic redemption, or tender offer, periods, subject to certain limitations. Across the NTR industry, redemptions are generally limited to 5.0% of NAV per quarter. Many of today's NTRs limit monthly redemptions to 2.0% of the NTR’s NAV, subject to the aggregate limit of 5.0% each quarter. NTRs are typically not obligated to conduct these quarterly tender offers.
Like most private real estate vehicles, the fee structure for NTRs often consists of a management fee and an incentive fee. Certain share classes may also have additional fees relating to the distribution or servicing of the vehicle. Even taking the maximum potential fee load for an Investor into account, today’s NTRs generally have a substantially reduced fee load compared to the early NTRs of the 1990s.
Valuation policies vary across the NTR landscape, but generally, assets are externally appraised by an independent third-party on an annual basis, with some managers conducting external valuations at varying frequencies which are typically monthly or quarterly. If the assets are not valued by an independent third-party, managers conduct internal valuations that typically involve a separate committee that reviews and approves the valuations. Assumptions such as exit cap rates and discount rates utilized for underlying portfolio valuations are often disclosed on an ongoing basis for NTRs either through regulatory filings or ad hoc reporting.
How is the Market Environment Today Impacting Non-Traded REITs?
In a market environment of high inflation, rising interest rates and increased likelihood of an impending recession, NTRs are facing one of their biggest hurdles in recent history as debt has become more expensive and market cap rates have been widening.[2] Nonetheless, through November 2022, NTRs have performed well relative to traditional investments. Some NTRs have benefitted from flexible investment mandates that have enabled them to pivot to being lenders and invest in real estate credit in this environment, which has generally contributed positively to performance.
As Investors search for liquidity, some NTRs have seen a recent uptick in redemption requests and a decrease in capital inflows. According to Robert A. Stanger & Co., Blackstone Real Estate Income Trust saw Investor redemption requests increase to an estimated $3.0 billion in the Third Quarter of 2022, compared to $711 million in the First Quarter of 2022. With these increasing redemption requests, Blackstone and Starwood recently announced that their NTRs had experienced redemption requests that exceeded their respective monthly limits noted above and, as a result, that they are only redeeming a pro rata portion of investors’ redemption requests, consistent with their respective fund documents. That being said, in January 2023, the Regents of the University of California (“UC”) and Blackstone announced a long-term strategic venture in which UC will invest $4.0 billion in Blackstone Real Estate Income Trust. Blackstone will then contribute $1.0 billion of its Blackstone Real Estate Income Trust holdings as part of a strategic venture with UC.
Although there has been positive momentum in the NTR space in the past year – both in terms of fundraising and resilient performance – media reports have speculated on the potential for increased scrutiny and regulations for these products. Recently, the North American Securities Administrators Association (“NASAA”) announced that it is proposing that each state adopt a new policy statement that would limit how much an Investor can buy into a non-traded REIT and prohibit such funds from paying out distributions from capital earned from selling shares.[3]
These rules would limit an Investor from putting more than 10% of their liquid net worth into an NTR, which critics of the proposed regulation have described as “a solution in search of a problem.” This idea of limiting allocations to NTRs stems from the NASAA’s view that newer Investors may be at higher risk in the situation that an NTR may limit redemptions. However, many Investors and managers oppose this potential rule change, as they believe these concerns have already been addressed with revisions to policies and structure. ’40-Act REITs, which are generally viewed as having a higher degree of oversight as a result of their registration with the SEC, are not subject to the NASAA or other state-by-state regulations and therefore these proposed limits would not apply.
Insights from Industry Experts
Alliance interviewed our colleagues and friends at Hines and KKR, who are experts in this space, to provide their insights on the benefits of NTR strategies, how they believe the opportunity set will evolve over the next several years and misconceptions about the NTR space.
Q: What are the primary benefits to Investors in non-traded REIT strategies?
Hines: “Non-traded REITs can provide Investors indirect ownership in institutional-quality real estate with the potential to offer stable tax-advantaged income combined with reduced volatility due to not being correlated to public equity markets. Often times, non-traded REITs offer diversification by asset class, geography, and tenant industry. The income and growth potential of non-traded REITs can make them an effective alternative investment in Investor portfolios.”
KKR: “We believe that allocations to semi-liquid real estate strategies can be highly beneficial for many Investors – both institutions and individuals – as an efficient way to gain exposure to private real estate. In our view, non-traded REITs are generally more accessible to a wider range of Investors compared to private funds and often include beneficial features such as lower minimums and suitability standards, immediate deployment at subscription, tax reporting via a 1099 rather than a K-1 and a level of liquidity (quarterly, subject to fund-level caps). However, as an increasing number of non-traded REITs become available, understanding the differences between product structures is an important consideration for Investors seeking to unlock the benefits of these strategies.
When it comes to structure, the two most common formats for semi-liquid real estate strategies are non-traded REITs and ’40-Act REITs, a newer innovation. These structures are meaningfully different in a number of ways. For example, at KKR we elected to use the ’40-Act REIT structure for our solution, KREST, because we believed registration with the SEC would provide both increased protections and reduced operational requirements for our Investors as compared to non-traded REITs, while also preserving all the benefits of the traditional non-traded REIT structure.
Traditional non-traded REITs are regulated under state-by-state Blue Sky laws, which can result in certain limitations for Investors. For example, these products can be subject to state-by-state concentration limits that apply to traditional non-traded REITs and BDCs in aggregate, thus limiting Investors or financial advisors who want to increase their exposure to the growing universe of semi-liquid alternatives.”
Q: How do these firms believe the opportunity set will evolve over the next several years?
Hines: “We believe the next 12-24 months will likely present a window to acquire high quality real estate assets across sectors at a significant discount to historical pricing averages. That being said, the opportunities will no longer just come from the brokerage community but also from banks and local principals.”
KKR: “We’ve seen a lot of new entrants in the NTR space as a whole. Just as we are seeing an increasing number of managers adopt the ’40-Act REIT structure as a result of its comparative benefits relative to other products, we can expect that Investors and managers alike will continue to gravitate towards incremental evolutions over the next few years. In an increasingly competitive market, successful products have to be differentiated and we believe this applies across investment strategy, product structure and the Investor experience.
When it comes to investment strategy, we believe funds with the flexibility to dynamically adjust allocations based on the stage of the market cycle will be increasingly important to Investors in the new macroeconomic regime. We believe Investors will gravitate towards dynamic and resilient investment strategies that can offer returns that are uncorrelated to traditional public markets.
We believe NTRs with balanced allocations across equity and credit are well-positioned to provide Investors with important portfolio diversification benefits, in addition to tax-efficient yields, at a time when the traditional 60/40 portfolio allocation strategy is proving less effective, as we’ve seen correlations between equities and fixed income increase in the current inflationary environment.
You can’t ignore the importance of performance and the Investor experience to determine which products will be successful. We believe that the managers that are able to navigate changing macroeconomic environments most successfully for their Investors should continue to gain market share from fundraising. We believe integrated solutions that deploy capital prudently with an intellectually honest assessment of risk will generally provide the better Investor experience.”
Q: There has been a lot of recent press on the non-traded REIT space. What incorrect market assumptions are made about the strategies?
Hines: “The most common misconception about non-traded REITs is about the structure. In the past, legacy REITs operated under a finite structure which included high up-front fees, limited liquidity, and a lack of transparency. As a result, there were some poor performers that have caused many financial advisors to stop recommending non-traded REITs with their clients. However, the non-traded REIT space has evolved from a finite to perpetual structure, which has benefitted both Investors and the asset manager. From the Investor standpoint, the structure offers increased transparency with periodic (often monthly) valuations, distributions and liquidity, subject to volume and other limitations of the REIT’s share repurchase program. The fees have also been drastically reduced, allowing for deployment of a higher percentage of Investors’ funds into investable real estate. The liquidity is now up to the Investor and financial advisor to decide when the optimal time is to request liquidation of the investment instead of waiting for the asset manager to execute a liquidity event. This perpetual REIT structure has been very well received in the market, as seen by the increased capital inflows into non-traded REITs. However, there are still incorrect assumptions from advisors who are unaware of the evolution of the non-traded REIT structure and therefore, continue to associate them with high up-front fees and no liquidity. The other assumption that is quite timely today is advisors believe the private real estate markets will move in similar fashion to the public markets. Historical data would disagree.”
KKR: “We think one of the biggest misconceptions about the NTR space is that the products are only for private wealth or individual Investors. This isn’t the case, and our experience has been that these products can be a great investment solution for both large, institutional Investors and individual Investors.
There are large Investors with capacity to invest in limited partnerships, both closed-ended or open-ended, are choosing these types of products because of the ease of use and efficiency of a single fund that can invest in income-oriented private real estate equity and credit.”
Conclusion
The progression of the NTR space has grown significantly since first introduced in the 1990s. This space attracts the attention of many Investors as large, well-known investment managers now offer competitive vehicles. Capital flows to the market totaled over $30 billion in 2021, with a similar trajectory in 2022. At Alliance, we continue to research and analyze this evolving market, the strategies and the key players in the space. We invite you to contact us for more information on our expertise in this area.
About Alliance Global Advisors
Alliance Global Advisors (Alliance) is a women-owned consulting firm focused on developing strategic growth solutions for real asset investment managers. Advising clients with over $400 billion in assets under management (AUM), Alliance partners with organizations to provide an informed, independent perspective, continued education and an innovative approach to attracting capital in a competitive market environment. Our experienced team is committed to empowering the real asset investment community to elevate best practices. Our partnerships allow senior management teams to focus on what matters most: diligently managing Investor capital, creating value and delivering exceptional returns in a performance-driven market.
Disclaimer: This blog was originally published in January 2023 and will be updated periodically to reflect changes in the industry. The content may contain or cite personal and/or professional opinions that differ from the views of Alliance.
The views expressed in the blog post do not necessarily reflect the views of Hines and its affiliates (“Hines Group”) or KKR and its subsidiaries (“KKR Group”). Neither Hines Group, nor KKR Group nor the author guarantees the accuracy, adequacy or completeness of information provided or linked in the blog post. The information in this post is only as current as the date indicated and may be superseded by subsequent market events or for other reasons. Nothing contained in the blog post constitutes investment, regulatory, legal, compliance or tax or other advice nor is it to be relied on in making an investment decision. The blog posts should not be viewed as a current or past recommendation or solicitation of an offer to buy or sell any securities or to adopt any investment strategy and accordingly should not be construed as such.
[1] https://www.jdsupra.com/legalnews/the-past-present-and-future-of-the-non-41844/
[2] Source: GreenStreet
[3] Source: https://therealdeal.com/2022/08/30/regulators-weighing-new-rules-for-non-traded-reits/