Investor demand for public non-listed real estate investment trusts (REITs), non-listed business development companies (BDCs) and other direct participation programmes exceeded USD24.5bn in 2013.
This is an all-time record according to The Investment Program Association (IPA), a trade association for direct investment vehicles, and Robert A Stanger & Company, an independent investment banking firm that specialises in direct investment securities.
Data developed by Stanger show equity capital flows to direct investments in 2013 were up USD11.2bn from the 2012 total of USD13.4bn – an 84 per cent year-over-year increase.
"Three primary factors helped the direct investment industry attain this level of popularity among retail investors and their advisors," says Kevin Gannon, managing director of Stanger. "The evolution of this relatively young industry will ultimately lead to substantially higher levels of investment in coming years."
The first factor that contributed to the successful fundraising was the liquidations of non-listed REITs formed in prior years which have produced attractive total returns to investors. Second, investors are attracted to the continuing yield advantage of real estate and private corporate development loans over more traditional fixed income investment alternatives. These yields are typically six per cent or more. Third, the continuing uncertainty of the impact of macro-economic forces on the stock market makes portfolio diversification attractive to investors.
"Allocating funds to direct investments, which have low correlations with financial market instruments, is a logical and productive strategy in the current economic climate," says Kevin M Hogan, president and chief executive officer of the Investment Program Association. "Investors continue to prefer reliable current income to the pursuit of more speculative growth, and the significant yield advantage available from most direct investments continues to attract investors seeking current income.”
What was a kaleidoscope of geopolitical, economic, fiscal and monetary uncertainties has resolved somewhat over the past few months. While the long-term implications of the Arab Spring on Middle East security and world oil markets are still clouded, the immediate threats of Syrian chemical arsenal and Iran's development of atomic weapons have been forestalled. Congress has approved a budget and a debt ceiling compromise appears more likely.
"Considerable uncertainties remain which justify a prudent investment allocation to Direct Investments," says Gannon. "Those include the pace and sustainability of the U.S. economic recovery, the rate of the Fed's downsizing of quantitative easing, potential revisions to the tax code, and the longer-term potential for inflation."
The direct investment industry's increasing annual investment rate – from around USD6bn to USD7bn in the mid-2000s to over USD24bn in 2013 – reflects an evolution of the product, more robust education of financial advisors and investors to the potential benefits of the various classes of Direct investments, the introduction of non-traded public business development company products to this market, and the emergence of a successful investment record for the industry following the bursting of the real estate valuation bubble in 2007.
"The most significant factor lifting the industry to new levels of equity fundraising is successful liquidity events," says Gannon.
Liquidity events can take the form of portfolio sales, mergers or listings of matured non-listed REITs formed in prior years. These events provide either liquidating cash distributions to investors or shares of a publicly traded company which can then be sold on a national exchange. During 2013 seven non-listed REITs provided liquidity events which returned over USD16bn of equity to their investors.
Approximately 80 per cent of total capital raised by direct investments in 2013 was committed to public non-listed REITs. Prior to 2013, the highest annual total for non-listed REIT investing was USD11.5bn in 2007.
The non-listed REIT industry has become a primary incubator for listed REITs. Since the year 2000, the non-listed REIT industry has raised approximately three times as much new capital as traded REIT IPOs. When secondary offerings are included in the traded REIT total, non-listed REITs have accounted for approximately 30 per cent of total annual investment in the public REIT industry.
BDCs, which were introduced into the independent broker dealer channel as recently as 2009, have grown to become the second largest sector of the public direct investment marketplace. These investments provide financing for growth to businesses in a wide variety of industries which are otherwise capital constrained.