Commercial Mortgage REIT IPOs: Coming Up Short

There has been a recent wave of commercial REITs announcing public offerings in the third quarter of 2009. Despite the seeming popularity of this business trend, there are some clear problems in the realm of commercial mortgage related REITs. The unifying theme among these REITs to go IPO this year is that many of the offerings were only able to raise half of their intended capital (or less). Furthermore, the weakened demand for commercial REITs is amplified by multiple firms postponing their initial public offerings.

The first of the recent REITS to go public and miss targets was CreXus Investment CP (CXS) which debuted on 9/16/2009. The original goal for this offering was to issue 33.3 million shares at $15/sh (~$500 million). They were only able to issue 13.3 million shares at $15/sh (~$200 million) or 40% of their target. Currently, CXS shares are trading at $14.16 (as of close on 10/1/2009), down 5.60% since its initial offering.

The next offering to follow suit was Colony Financial (CLNY). Tom Barrack, founder of the LA based private equity and real estate firm, Colony Capital launched the latest venture Colony Financial on Wednesday September 23, 2009. The original terms of the deal were intended for 25 million shares to be issued at $20/sh (~$500 million). The offer only ended up issuing 12.5 million shares at the original price of $20/share (~$250 million) or 50% of the target. Currently, CLNY shares are trading at $19.51 (as of close on 10/1/2009) and has remained in a relatively small trading range since going public ($19.25 - $19.66).

The same day CLNY went public, yet another commercial mortgage REIT Apollo Commercial (ARI) had its IPO. Apollo cut its proposed deal size from 20 million shares at $20/sh (~$400 million) to 10 million shares at $20/sh (~$200 million) which is also half of the intended offering size. Apollo shares are off more than the previously mentioned securities since going public. As of close of market on 10/1/2009, shares traded at $18.15, down 9.20% since going public last week.

In addition to these companies coming up short on their proposed deals, two other companies actually postponed their IPOs. Foursquare Capital (FSQR) and Ladder Capital Realty Finance (LCG) are the latest companies to withdraw their offerings. Foursquare was set to go public last Thursday (9/24/09), and Ladder Capital was aiming to go public this Tuesday (9/29/09). It would not be surprising if the failure of CLNY, CXS, and ARI to raise expected capital was the main consideration for these firms to postpone their offerings.

The next obvious question is, why are these mortgage backed real estate investment trusts having trouble raising capital? The most apparent answer is the timeframe in which these securities went public. The sheer number of REITs going public within a close time proximity could be the reason for the lack of investment.

Another answer may lie in the actual property that these companies own. Unlike conventional REITs which own real property, these trusts own mortgages. According to analysts, the uncertainty of the blind pool of assets owned by these companies is unsettling to investors.

Suspicion also surrounds the fact that these private equity firms are turning to the public to raise capital. This may be a signal that all other sources of capital have been tapped out, and this approach of seeking public funds indicates a last resort strategy by private equity firms.

Although there may be some opportunity in the CMBS market, the inability to raise sufficient capital by recent offerings has dwindled investor confidence. Negative news surrounding the latest public offerings by commercial mortgage REITs will likely take time to subside before this segment gains steam.

Disclosure: No positions in ARI, CXS, or CLNY as of 10/1/2009.

Comments

[F. Brian O'...:]

they're having trouble because they were stupid ideas to begin with. Leaving aside the fact that they own nothing (blind pools) and who knows what kind of crap they're going to buy, their structure is awful. They are externally managed where the manager takes enormous fees and the investors take all the risks. I'd also note that mortgage REITs do not have a proud history, most of them have either gone bankrupt or in distress at some point in their history. Credit goes to the banks for being able to peddle this garbage as much as they have.

Oct 02 03:09 PM

[Alex Khande...:]

I mostly agree with the above comment. The blind pools of assets and manager fees make these securities turn investors away. I should have emphasized the negative aspect of the exorbitant manager fees in the article more. The managers make money regardless of performance, and investors bear the brunt of the risk.

Oct 02 07:01 PM

[Mad Hedge F...:]

rdc The vultures are circling the embattled commercial real estateindustry, ready to swoop down and devour the carrion before it’s dead.A trio of REIT IPO’s have hit the market this week looking to buy realestate for pennies on the dollar, as well as the bargain basement debtof other troubled REIT’s. JP Morgan, Citibank and Barclay’s launchedtheir Apollo vehicle (ARI). Bank of America and Morgan Stanley came outwith a new security called Foursquare (FSQU). Not to be outdone, Bankof America, Merrill Lynch, Goldman Sachs, and UBS followed up withtheir Colony (CLNY) instrument. This is a classic example of new equitycoming in and taking ownership of assets where the previous owners havegone to money Heaven. Commercial real estate lending exploded from $1trillion in 1988 to $3.5 trillion in 2007, and some $2 trillion of thathas to be refinanced this year. Takers are few, with banks reeling inleverage ratios, insurance companies gun shy, and the collaterized debtmarkets in intensive care. The TALF is expiring at year end. Did I hearsomeone shout “Bail Out?” Many listed REIT’s will only survive becausetheir rules limited them to mere 2:1 leverage, and were able to raise$16 billion in new equity since March. That has helped propel the DowJones REIT Index ($DJR) up 84% from the lows. More highly leveragedprivate investors and regional and community banks not so constrainedare choking on their holdings, and many are limping on by letting markto market rules fall by the wayside. This is why I am not recommendingbank stocks or REIT’s at these levels. The new vulture issues may beanother story. I was involved in a strategy at Morgan Stanley to Hooverup Houston office buildings on the cheap in the wake of the earlyeighties oil bust. The lucky investors got a tenfold return on theircapital.

Oct 03 02:15 PM

[Alan Young:]

It's weird that after so much time of people apparently just wringing their hands over the state of CME debt, not one but 4 (or 6) companies trying to exploit the problem try to IPO in the same week!

If ONE company had IPO'ed this business model, doesn't it stand to reason that they could have attracted most of the capital that ended up buying into all of these startups? And that would have been deemed a success.

I'm sure there is opportunity in the sector, but maybe enough for one or two brilliant managers. With four or six, someone is going to get screwed.

Oct 04 02:35 AM

[Patrick Harden:]

Even the successful launch of Starwood Property Trust (STWD) has produced nothing in the way of return. The stock is barely trading above the $20.00/share IPO price and has declared a Q3 dividend of just $0.01/share. Worse, the company has already declared the Q4 dividend to be just $0.10/share. I posted an article back in July (seekingalpha.com/artic...) that outlines exactly why these REITs are not going to work out. They're just another debt-for-equity exchange.

Previously existing mREITs that include distressed debt (mostly non-agency RMBS) like Redwood Trust (RWT) and Chimera Investment (CIM) have much better returns AND a track record.

Oct 05 12:04 PM

[H.J. Huneycutt:]

I don't see much of a point in buying into these vehicles, either. I've been mostly bullish on REITs since March, but that's precisely why I can't see the point in these vehicles --- why buy into a "blind pool" when you can buy established REITs with detailed financial information and a known pool of assets at bargain prices?

Oct 05 01:17 PM

[PAD:]

Can somebody quantify these "enormous" fee's taken by the managers of the funds?

i've read the S-1's of CLNY and STWD and it looks like they take 20% profits above a stated threshold (i think CLNY's was 8% ROE for the opco). Doesn't seem like that high a fee to pay to invest alongside the private equity folks managing the opco to me.

I haven't done enough work on these new REIT ipo's to make any bold claims but i will offer one observation: This is the most hated sub-sector out there.

Every blog and news source out there hates these new REIT ipo's and they all mention the same things: Blind trust with no track record (not true for CLNY, whose mgt team led the hugely profitable buying from RTC 20 years ago), no dividends (yet), private equity selling to common/retail holders (even though pvt eq not cashing out a penny of the proceeds) and the "wave of IPO's" as a sure sign of a top just like dot-com (no comparison on any book value or other valuation metric).

And finally, the sell-side initiations by the bankers, i mean research analysts, have also been fairly muted (short 5-6 page initiations, not bullish at all).

I'm a buyer of anything this hated. Portfolio strategy--small positions in 4-5 names. Time will tell.

Oct 13 10:42 AM