Vereit Inc (fka VER)

[Enterprising Investor]

Investors Rethink American Realty-Linked REITs (10/31/14)

Accounting Woes Shake Popularity of Family of Unlisted Trusts

By Craig Karmin and Robbie Whelan

No one raises more money from small investors seeking to profit in real estate than Nicholas Schorsch. His family of nontraded real-estate investment trusts has raised nearly $21 billion since 2008, primarily from individuals investing through brokerage firms and investment advisers.

But a disclosure this week of accounting irregularities at his flagship company, publicly traded American Realty Capital Properties Inc., could spill over to his massive fundraising machine.

Shares of American Realty Capital Properties—one of the nation’s largest landlords to bank branches, restaurants and drug stores—have sunk 28% since the company said Wednesday that two executives had resigned after a measure of cash flow for the first quarter was overstated. The company said the employees intentionally decided not to correct the error in the second quarter. The two executives couldn’t be reached for comment.

The Securities and Exchange Commission plans to open an inquiry into the company related to the accounting disclosures, according to a person familiar with the situation.

The amount of money involved was relatively small—$23 million was said to be misstated. And Mr. Schorsch played down any spillover effect during a conference call this week with about 300 broker-dealers whose firms market his unlisted REITs. He said the accounting irregularities at his public REIT wouldn’t have any impact on his family of unlisted REITs.

Some brokers, however, say they have seen an increase in the number of investors looking to sell shares in some of the dozen unlisted REITs sponsored by companies affiliated with Mr. Schorsch, American Realty Capital’s founder and chairman.

“Some of the management of the nontraded entities are the same people managing an entity with accounting issues,” said Scott Crowe, chief investment officer for Resource Real Estate, an investment firm that buys shares of nontraded REITs on the secondary market. “It’s definitely a reputational thing.” Mr. Crowe said he had seen a slight uptick in the volume of investors looking to unload their shares of American Realty Capital products.

An executive at Central Trade & Transfer, a Lehi, Utah-based company that buys unlisted REITs in the secondary market, said that over the past 12 months his firm had traded only about $75,000 worth of American Realty Capital REITs. But this week, he said, the firm received calls from investors looking to sell a combined $2 million worth of these REITs.

National Planning Holdings Inc., which trades one of Mr. Schorsch’s unlisted REITs, told members on Thursday that it was temporarily suspending sales of the REIT “until further review,” a spokeswoman said. The firm has a network of four broker-dealers and nearly 4,000 registered representatives and advisers.

LPL Financial Holdings Inc., the largest network of independent financial advisers in the U.S., notified business partners this week that it has put some of Mr. Schorsch’s unlisted REITs “on our watch list.” The firm cited the “unknown extent of the impact” of the disclosure of the accounting irregularities, the note said. An LPL spokeswoman declined to comment further.

Andrew Backman, a spokesman for American Realty Capital, declined to comment for this article. Mr. Schorsch couldn’t be reached.

American Realty Capital Chief Executive David S. Kay said in a conference call Wednesday that the company had determined there was no intent to overstate the accounting measure for the first quarter, but that the second-quarter number was based on a calculation made “in order to conceal the error from the first quarter.” He called it “some bad judgment.”

Not all American Realty Capital investors think it’s time to sell. Shimshon Plotkin, founder of Plotkin Financial Advisors in Chevy Chase, Md., said he was buying shares of American Realty Capital Properties for clients during this week’s selloff.

Mr. Plotkin said he was encouraged that the accounting issues affected a small amount of money and were found by internal controls. “This is a superior management team,” he said. He said he had put “tens of millions of dollars” of his clients’ money in American Realty Capital nontraded REITs, adding that since 2011, these REITs have produced strong returns.

Mr. Schorsch began his career in real estate in the late 1990s by buying up hundreds of bank branches, which he eventually rolled into a REIT called American Financial Realty Trust, based in his hometown of Jenkintown, Pa. In 2006, he stepped down as CEO of American Financial and founded American Realty Capital as a nontraded REIT the following year. Unlike conventional REITs, nontraded REITs aren’t listed on a public stock exchange. Instead, shares are sold to small investors through networks of broker-dealers and personal financial advisers. The funds have a life cycle of anywhere from two to 10 years, which involves raising money, buying property and eventually liquidating through a merger or stock listing and returning money to investors.

Mr. Schorsch began raising billions of dollars through more than a dozen different funds, most of them using some variation of the American Realty Capital name, and expanded his empire by buying up brokerage firms as well, many of which sell shares in his REITs.

Meanwhile, American Realty Capital Properties began trading on Nasdaq in 2011 and embarked on a program of rapid expansion, becoming by this year the largest U.S. owner of single-tenant commercial real-estate. In July, American Realty Capital Properties closed on the $1.5 billion purchase of about 500 Red Lobster restaurant locations.

Mr. Schorsch’s unlisted REITs have raised $20.8 billion over the past seven years, which is more than any other REIT sponsor, according to investment bank Robert A. Stanger & Co. The American Realty Capital family has raised $6.6 billion for its unlisted REITs in 2014—or more than half of the money raised by the entire unlisted REIT industry this year. Stanger estimated that the average investor contribution was around $30,000.

Write to Craig Karmin at [e-mail] and Robbie Whelan at [e-mail]

http://online.wsj.com/articles/investors-rethink-american-realty-linked-reits-1414789368