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Methodology: Non-Traded REITs

By Michael McDaniel
Co-founder and Chief Investment Officer

If you’re using non-traded REIT NAVs to analyze the risk and reward characteristics, “you’re doing it wrong.”

Last March, I had the pleasure of attending Bluevault’s annual conference where home offices and advisors met in Orlando Florida as a part of their firm’s alternatives due diligence process. It became abundantly clear that firm’s had been led astray by following non-traded REIT NAVs for their supervision and due diligence. Our experience confirmed that the methodology Nitrogen uses for analyzing non-traded REITs was groundbreaking and considerably more robust than anything available.

Our core belief that “price is truth” serves us extremely well within the publicly traded investment landscape. But, we acknowledged early on that using NAVs for non-traded investments wasn’t robust. Our Risk and Methodology team has designed a robust analysis algorithm for non-traded investments that uses a 10 factor methodology for analyzing non-traded REITs (and another 10 factor framework for analyzing non-traded BDCs). We scour the filing of approximately 150 non-traded REITs, so you don’t have to.

Today, thousands of advisors and many home offices lean on our proprietary calculation to determine the risk/return profile on non-traded REITs (and non-traded BDCs).

Non-Traded REITs Methodology Overview

For traditional investments in Nitrogen, we incorporate daily or monthly price data, as appropriate, and dividends from a varied market environment; January 1st, 2008 to most recent market close.

Our proprietary methodology for calculating the risk profile (return and volatility) for Non-Traded REITs assesses the following criteria:

Short-Term Liquidity: A measure of near-term volatility, our methodology penalizes low liquidity levels.

Return on Assets in Relation to the Weighted Cost of Debt: As a measure of levered loss, REIT’s where the use of leverage results in a negative contribution are penalized.

Leverage: The use of leverage on a REIT’s balance sheet can accelerate both losses and gains, resulting in higher underlying volatility. REITs that utilize extensive leverage are penalized.

Interest Coverage Ratio: REITs that can easily service their debt are rewarded whereas REITs that cannot are penalized.

Dividend or Distribution Yield: For many of the alternatives on our platform we rely heavily on the stated dividend yield for our return expectation. REITs with stable or increasing dividends are rewarded while alternatives with unstable or stopped distributions are penalized.

Funding Requirements for Offered Redemptions: REITs that offer Redemptions are not penalized. However, REITs which offer redemptions that also require substantial funding to fulfill their obligation to shareholders are penalized.

Amount of Debt Maturing in the Near Future: A measure of rollover risk; as near-term debt obligations become due the obligations can either be met (through the liquidation or maturity of assets) or converted into new debt. REITs facing refinancing difficulties are penalized.

Ratio of Fixed to Variable Rate Debt: REITs with substantial variable rate debt, and thus carry substantial interest rate risk, are penalized.

Modified Funds From Operations (MFFO) Payout Ratio: A short-term indicator of sustainability, REITs that currently pay out initial shareholder equity and/or require funding to finance their dividends are penalized.

Percentage of MFFO Paid Out in Distributions Since Inception (Excluding DRIP): A long-term indicator of sustainability, REITs that have (net, since inception) paid out initial shareholder equity and/or required funding to finance their dividends are penalized. 

I was recently at a Nitrogen Bootcamp training event of ours in Los Angeles when an advisor piped up and asked, “In regards to BDCs or non-publicly-traded REITs, when we import one into Nitrogen, have you folks taken into consideration just a class of investments, ‘non-publicly-traded REITs,’ or…if I put in a specific REIT, are you going to give me a Risk Number for that REIT?” When we told him that we analyze the data of each one, his response was “Woooow. Do you have 20,000 people on staff?” While I can assure you that we don’t have 20,000 folks on staff, I can say that our risk and methodology team is dedicated to doing risk right, and in a way that nobody else does.

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