Welcome to the CAPFUNDR family, and thank you for trusting us with your real estate investment. This is the first of the regular quarterly reports you will receive as an investor in the CAPFUNDR REIT Value Fund I. We hope that you will find these reports informative and helpful in understanding the strategy and results for your fund.
This was the Fund’s first quarter of operations, and we feel that it is off to a strong start. During the first quarter of 2016, the Fund was opened to investors, it raised the minimum amount required for its first closing, and it made its first four investments in non-traded REIT shares. I personally made the first investment in the Fund, and I’m excited to be sharing with you a strategy that I strongly believe in.
The Fund is focused on exploiting market inefficiencies, so our strategy is driven more by the availability of these opportunities than by overall market conditions. Market conditions are nevertheless important as they will affect the exit prices at which our REIT investments can liquidate their properties.
After rising 12.7% in 2015, the Moodys/RCA CPPI commercial property index declined by 0.5% in the first two months of 2016. The turmoil in capital markets was an important factor as financing rates increased and CMBS lenders pulled back from the market in response to plummeting oil prices and stocks, and widening corporate credit spreads. When financing is more expensive and less plentiful, property owners need to buy at a lower price to generate the same returns. CAPFUNDR’s view is that debt markets are stabilizing, along with the stock market recovery, and that overall real estate values will remain flat, or increase at a modest rate, for the foreseeable future. The following graph shows the inverse correlation between CMBS funding cost and listed REIT prices, and the recent recovery in both sectors.
We have made four investments in non-traded REITs since the Fund’s first closing. All four investments reflect the Fund’s key investment objectives:
They were purchased at an average discount to NAV of 28%.
Each company is implementing a strategy to either liquidate its portfolio or prepare for a listing of the company on a public exchange.
They invest primarily in office and retail properties, property types that are relatively stable and liquid.
Our largest position, Inventrust, is a company that has taken significant steps to improve performance and provide an exit strategy. This $3.5 billion REIT has been divesting non-core businesses to focus on their core portfolio of neighborhood and big box shopping centers. Last year they spun off their hotel portfolio as a listed public REIT, Xenia Hotels. This quarter, they have announced the sale of their student housing business and the spin-off of their non-core portfolio. The non-core portfolio, which consists primarily of underperforming office properties, will be put into a separate company called Highlands REIT. This leaves Inventrust with a focused retail strategy and opens the door for a public listing of the company.
While we do have some concerns about the quality of the non-core portfolio, we attribute a very low value to this portfolio. The two largest assets in the portfolio are leased to AT&T but are not currently occupied. We estimate the value of these properties to be at or below their debt amount, so we assume that the lenders will take the properties back when the leases expire in 2016 and 2017, and we attribute no value to these properties.
A second important step taken by Inventrust is the internalization of management. Like most non-traded REITs, Inventrust’s predecessor was externally managed. This means that the REIT was run by a manager who is paid a fee, much like a fund. By eliminating this management contract and making the key personnel employees of the REIT, the company has eliminated fees and created a management structure that is viewed more favorably in the market for public listed REITs.
Our second largest position, KBS REIT II, is managed by KBS, a company that manages over $10 billion of commercial real estate. We believe that the manager has a strong incentive to maximize the return of capital to their investors and to preserve their reputation for their core institutional business. The REIT is in the process of liquidating assets, and they made a special distribution to shareholders of $4.50 per share in late 2014 following the sale of a large portfolio of properties. They also recently formed a Special Committee composed of independent directors and engaged Evercore Group to explore strategic alternatives..
The chart below represents the portfolio composition grouped by property type. Office, the largest segment of the portfolio, accounts for 47.62%. Retail came in second place, which accounts for 30.64%.
Key Characteristics of REIT Investments
|Average Purchase Price to NAV Ratio||71.87%|
|Average Current Dividend Rate||4.86%|
Q2 2016 Outlook
During Q2, we plan to add to our existing positions and invest in new positions to increase diversification. We may also invest in some listed REITs that offer attractive dividends and trade at a discount to their NAV.
We look forward to commencing what we anticipate will be quarterly distributions following the end of the second quarter. The Fund is not paying a distribution for the first quarter as we have not yet completed a full quarter of operations.
In April, new SEC rules are being implemented that require non-traded REITs to report their NAV net of front-end fees. Many investors who bought these REITs at new issue will see a sharp drop of 15% or more in the reported value of their shares. Even though 15% or more of the invested amount was never invested in property because it went to pay fees and expenses, managers have until now been allowed to report the REIT’s NAV at par. Now, if 15% of the invested amount went to pay fees and expenses, the reported NAV will be 85%.
These new rules will not affect any of the investments we have made. All of the REITs we have purchased have completed their offerings and are already reporting NAV based on a valuation of their assets by a qualified independent valuation expert. We expect the SEC rules to create new investment opportunities as some investors will likely opt to sell once they realize that the value of their investment is significantly lower than they had been led to believe.
The second proposal affects sales of non-traded REITs to retirement accounts, which are regulated by the Department of Labor (DOL). The final DOL rules that were released last week will make it extremely difficult for commission-based brokers to sell non-traded REITs to retirement accounts. The DOL is imposing a fiduciary standard on brokers who make recommendations for retirement accounts. This means that the recommendations have to be in the client’s best interest. Again, many investors will be surprised to learn that their broker previously had no obligation to take their best interest into account.
While the DOL rules will have a negative long term impact on the viability of the non-traded REIT industry, we do not expect it to have much of a near term effect on secondary market sales of non-traded REITs. The rule primarily affects new issue sales and does not create any particular motivation to sell existing holdings.
As CAPFUNDR continues to build out its platform, we have added several key members to our team so far in 2016. We are very pleased by the impressive experience and infectious enthusiasm that that our new colleagues bring to CAPFUNDR.
Peng “Duncan” Dong – Senior Associate
Duncan recently joined CAPFUNDR on a full time basis upon obtaining his Masters in Real Estate from Harvard University. He is actively involved in analyzing the Fund’s investments and he adds significant real estate experience to the team. Prior to attending Harvard, he was a senior manager at Vanke, one of China’s largest real estate developers, and he was a portfolio manager at Blackstone’s real estate arm in China.
Darius Grant – Head of Capital Markets
Darius will lead CAPFUNDR’s direct outreach to investors, including advisors, family offices, and institutions. He brings a deep background in capital markets as well as extensive institutional relationships. Most recently, he has been advising institutional investors on risk management strategies. Previously he was a Managing Director at Citibank where he raised capital for real estate and fixed income funds for some of the largest fund managers in the US.
Robert “Robb” Fishman – Chief Operating Officer
Robb will focus on expanding and managing CAPFUNDR’s organizational infrastructure. He brings over 20 years of experience in finance and corporate development, and he is a CPA. As a former Director at Deloitte, he worked with large investment firms including KKR and The Blackstone Group. Most recently he was CFO of a private equity firm where he oversaw $500 million of real estate assets.
Your trust and support are much appreciated. Please feel free to contact us through www.capfundr.com if you have any questions.