Your recent article "Zell wants to team with Utah" in the Dec. 23 issue described so-called "friendly" tender offers in two real estate commingled funds. PCA was asked to review one of the tender offers for a client, an investor in one fund, and asked the question: "Friendly for whom?" We believe the process followed was flawed, created significant conflicts of interests, and raised the question of who is looking out for the interests of the smaller investors.
In this situation, an affiliate of a prominent real estate consultant, working with one fund investor, offered to buy out the other investors, albeit at a "slight" discount to the fund's reported June 30, 1996, net asset value. In the third quarter, the adviser reported an increase in the fund's value that was not taken into account in the offer.
At the same time the consultant also approached the adviser and indicated while there were no "guarantees," their client was "inclined" to allow the adviser to continue to manage the portfolio, assuming they could reach agreement on a revised fee schedule, more appropriate for a separate account. We note the consultant also counts among its clients another investor in the same fund. We were told the consultant would not advise this client as a seller due to the conflict of advising the potential buyer.
The consultant also advised us that it intends to approach other advisers on behalf of certain large clients with portfolios approaching liquidation with similar tender offers. These conversations have been confirmed by other real estate advisers. While there are never any "guarantees" made by the consultant regarding the adviser's continued retention, it is clear the buyers are "friendly" to incumbent management.
So, who benefits from this activity? The adviser clearly benefits. It retains a fee base it would otherwise lose if it sold the properties when the portfolio reached its expiration date. The process is quiet in that none of the advisers to date has put a portfolio up for auction. Of course this tender offer is "friendly" to it.
The buyer making the tender offer benefits. It acquires a portfolio at a discount to net asset value. But those in real estate know that NAV calculations based upon appraisals lag the market. So, appraisals lagging the market on the way down almost certainly are going to lag the market on the way up. This has been confirmed in many real estate portfolios in which assets recently sold traded at prices above appraised value. It is likely that those making the tender offers receive an even bigger discount to NAV simply as a result of the inefficiencies of the appraisal process. The motivations on the buy side are clear. It wants the process to be quiet so the portfolio is not put up for sale in an auction environment, which might result in a higher price.
The consultant benefits. It receives fees in connection with these transactions in representing the buy side. It would be interesting to query whether its other clients in the fund benefit from this activity when they are on the sell side in the same transaction.
So do the smaller minority partners benefit? In this situation, the adviser refused to counsel its investors as to what course of action to take because, we were told, of its conflict in being able to continue to manage the portfolio. Any adviser in this situation is clearly conflicted.
The investors in the fund were not apprised of the future plans for the portfolio, so they were faced with the Hobson's choice of either accepting an offer they knew to be below market value or continuing to remain a minority investor, with no control, without having any knowledge of the future plans for the portfolio - not, in our view, an attractive set of alternatives.
Is the price of liquidity worth this process? That's the heart of the question for many of these smaller investors, and what the advisers, the consultant and their buy-side clients count on in these transactions. As one of the adviser's representatives said to us, "We aren't talking about 20% discounts here."
True enough, but in a business in which performance is measured in basis points, it appears the incremental performance is being taken at the expense of the smaller, minority investors, and none of the parties mentioned above appear in any way motivated to protect their interests.
In a corporate environment, shareholders look to the board of directors to maximize shareholder value and represent their interests. The board has a clear fiduciary duty to do so or find someone who will.
In the situation referenced above, the very organization that should have represented all of the investor interests had a conflict of interests. In our view, these "quiet" and "friendly" tender offers only clearly benefit the buyer, the adviser and the consultant.
What should be done?
We think once any portfolio is put in play by a tender offer from any source, an auction environment should be created to ensure the minority investors receive the highest price and best execution for their interests. If not, the advisers should do what they originally promised their investors: put the assets up for sale and let the market determine their values. nNori Gerardo is managing director of Encino, Calif.-based Pension Consulting Alliance Inc. and works out of its Portland, Ore., office.