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Comment: The discrepancy in REIT share pricing: By Bryan Gordon, Chairman and Managing Director, Madison Capital Management, New York.

There is a significant discrepancy between the true value of non-exchange listed REIT shares and the inflated prices at which they are being sold to investors.

This practice is undermining the credibility of this market, and will likely lead to a fall-out over time as investors seek to exit their positions and realise the value of their original investment.

Several of the largest non-exchange listed, finite-lived REITs (F REITs) continually issue shares at a par value of USD 10 per share.  The proceeds from the sales of these shares are used to purchase properties, and to pay hefty upfront fees to the sponsors of 12%-15%, or higher.

Although investors are typically sold on the basis that they will receive annual cash distributions of 7%-8% on their investment, it is unlikely these distributions will be able to be paid solely from operating cash flows.  In the near term, at least, investors who wish to cash out may well not recoup their initial investment. 

Two factors are primarily causing this situation: imprecise Net Asset Values ("NAV"), and significant upfront fees.  The valuation of the assets is left up to the assessment of the sponsor, not the market or an independent appraisal on each asset.  It is possible, and quite probable, that sponsors are overpaying for assets and inflating NAV's.  Take into consideration the fees, and the true NAV per share could be 10%-20%, or more, less than USD 10 per share. 

Over the past two to three years, substantial sums of money have been raised by F REITs, especially from retail investors.  Individual investors seeking a safe haven in which to park their money have flocked to investment vehicles such as F REITs, lured in part by a possible exit opportunity 5-10 years down the road through a public listing of the shares.  However, the future may not be so bright for many of these F REITs, as investors become more skeptical of the pricing. 

Sponsors aiming for a public listing of shares at their chosen NAV—a liquidity option many current F REIT investors had banked on—may be thwarted as realistic values are placed on the shares by analysts, underwriters and institutional investors.  For instance, during the third quarter of 2004, CNL Hotels and Resorts (fka CNL Hospitality Properties) contemplated an IPO on the NYSE. 

The offering was not supported by institutional investors, and subsequently withdrawn when CNL realized that the prices investors were willing to pay was dramatically lower than their expectations.

Madison Capital Management, LLC is a New York-based alternative investment management firm specializing in distressed, real estate and special situations financial assets.

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