NLR Industry Insights: A Conversation with Nick Schorsch

In the January issue of NLR Industry Insights I cited three significant factors making 2014 an important year for the Non-Listed REIT industry; FINRA RN 12-14 (now SEC-FINRA SR 2014-006), the almost complete domination of the market by a single sponsor, and Wall Street’s growing interest in the industry.

I dedicated the January issue to RN 12-14 (now SR 2014-006). The SEC posted the proposed rule changes to the Federal Register on February 19. The 21 day comment period closed on March 12. A response from the SEC is anticipated within 21 days although the timeframe can be extended. I urge you to read the proposed rule changes and the Investment Program Association Comment Letter. To read the NLR Comment Letter (click here)

This month I promised to write about the almost complete domination of the market by a single sponsor. As I started putting my thoughts together, I realized it would be disingenuous not to mention the company by name or talk directly with the chairman and founder of the company before writing the article. Following are my comments about the market dominance by American Realty Capital and its affiliated companies (“ARC”). My comments are largely based on a telephone conversation I had with Nick Schorsch, the chairman and founder, earlier this month.

Nick and I have been friendly competitors and cooperative supporters of the industry since ARC first entered the market. At the beginning of this year I was cleaning out my files and came across some materials I received during a meeting with Nick and Bill Kahane, the president and co-founder of ARC, more than four years ago. One of the pieces listed what they considered to be best practices. They have since implemented those best practices and some of them changed the industry.

Much has been written about ARC and its dramatic growth. It is not my intention to write more about it here. Instead, I want to focus on the industry concerns that have been expressed about their market dominance. Is ARC going to blow up? Is ARC’s performance record sustainable? What are ARC’s intentions in the independent broker dealer community?

As a starting point, Nick and I talked about the significant transition the industry is going through. He talked about the highly successful, established sponsors and the difficulties presented to them by the market crash. He drew an analogy to highly visible transitions in other industries with companies like AOL, Kodak, Yahoo and now Time Warner. He recognized that the challenges created by the market crash were an opportunity for ARC. He clearly believes they took advantage of the opportunity by doing the right things. I asked what that meant. Nick’s answer was fundamental to this article. He said he wants to correct an industry misconception about ARC’s success. He feels it is critical to recognize that it is not the result of completing profitable liquidity events within a short period of time, but rather that the profitable liquidity events and the shorter holding periods were made possible by lower fees. He sees lower fees and the resultant performance as the key to the future not just for ARC, but for the entire industry.

When I asked Nick about the concerns over ARC’s market share, he said he believes the market will continue to get bigger much like the variable annuity market did, that ARC will not grow at the same rate and will therefore end up being a smaller percentage of the overall market. He further noted their move away from ARC sponsored programs and towards outside asset managers.

Nick’s response to my question about the sustainability of ARC’s performance record was realistic. He acknowledged the cyclical nature of real estate and the need to adjust. He went on to point out that they exited the net lease market after raising $8 billion of the $16 billion raised over the past several years, and are becoming involved with more diverse types of programs like their BDC.

ARC’s foray into the independent broker dealer world is a constant topic of conversation and I asked Nick about his intentions. He said as the market is changing, they are diversifying their revenue sources in several ways. One is through investment banking, with over $11 billion of M&A activity. Another is through their wholesale distribution effort where they are now utilizing more outside asset managers, and offering more diverse types of programs. The independent broker dealer channel is another way to diversify their revenue sources. In the past, only private equity, not public capital, was available to independent broker dealers. ARC has made public capital available. According to Nick, they are building their independent broker dealer network on a cultural model as opposed to other independent broker dealers that have moved away from being truly independent or are built on a platform model. They feel like the size of their independent broker dealer network is big enough and they now want to focus on putting operating systems in place to serve the needs of the mass affluent.

There were a number of things that stood out in my conversation with Nick. He appears to have a well thought out and cohesive business plan. He is embracing the cyclical nature of real estate and taking proactive steps similar to those taken by other forward looking companies to diversify his revenue sources. Perhaps most important is his commitment to building his reputation on performance at the investor level.

So is the industry in good hands? I think you have to evaluate the methodology, vision and underlying motivation if you are going to make an accurate assessment of ARC’s impact on the industry. You have to draw your own conclusions but at least you have some sense of Nick’s stated intentions. I have long believed that we are going through a transition that will make Non-Listed REITs, however they end up being packaged, a more widely accepted and important part of a truly diversified portfolio. We are well into the transition and it has the potential to be very positive for the industry and the investors it serves.

PS.

Between the time I finished writing this issue of NLR Industry Insights and the time it was scheduled to be released, RCS Capital announced the hiring of Todd Snyder and John Kearney; the closing of Snyder Kearney, LLC; and the creation of a new research division, SK Research ("SKR").

I followed up with Nick about his intentions. In not just an evolutionary, but what rises to the level of being a revolutionary time in our industry, he believes he is responding to an increased demand for research. Historically non-listed REIT and other direct investment offerings were closed after being only partially subscribed over an offering period that many times included a follow on offering and spanned as much as three years. Today many offerings are being fully subscribed in less than two years. The resulting increase in the velocity of new and follow on offerings has put a strain on the industry's research capabilities. Therein lies the opportunity for RCS Capital and SKR. Nick was careful in our conversation to differentiate between legal work and research, and he has a clear focus on research. While due diligence continues to be an aspect of SKR's capabilities, he is looking beyond due diligence to product, market, sector and institutional research. He believes SKR will continue to provide services to the small to medium size independent broker dealers that do not have the resources to respond to the increased demand for research. He also envisions an educational component that will benefit advisors and their clients.

All of this once again raises questions about ARC's market dominance. Can the research really be independent? Nick cites Greenstreet as a working model – even though they are owned by Wells Fargo, Bank of America uses their research on a regular basis. Is there going to be a void in the independent due diligence community and if so, who is going to fill it? You still have to be the judge. - m

Martel Day
Principal
NLR Advisory Services, LLC