Accessing Liquidity in REITs and Private Real Estate Markets with Brian King

The Unpredictability of Broker/Dealer Channels

[00:02:57] Dean Barber: When somebody buys into a non-traded real estate investment trust, unless they’re doing it very late in the stages of the fundraise, they really have no way of knowing whether the person that’s issuing that or raising the funds is going to reach those objectives.

[00:03:14] Brian King: That’s exactly right. Oftentimes, that money is raised through the broker/dealer channels. They reach out to different broker/dealers and say, “Hey, we would love for you to help us raise this capital.” Typically, the end investor either likes the idea of investing in or the possibility of it is investing in. And if they do like it, they can invest their money into that. But oftentimes, to your point, it’s a blind pool. You don’t know what they’re specifically going to be invest in until they have the money to go buy these assets.

[00:03:50] Dean Barber: Yeah, I’ve looked at those, and we’ve actually used those from time to time with clients over the years. But the thing is that I would always wait until they’ve raised 90% of the capital that they want to raise, that they’ve already purchased buildings. We know what the prices were, what the yield is, and what the occupancy is. And they’re at the final stages. And I would say, “OK, that’s something that’s attractive.” But I would always shy away from those ones where it’s a startup. In the early stages of the fundraising, get a bunch of money together and start buying some properties and see what you get. Then, we can make a decision.

The Different Dynamics of REITs

[00:04:28] Brian King: That’s right. At the end of the day, REITs are just one type of a structure. There are a lot of other structures that are out there, but REITs have a couple of different dynamics as far as how they can put that capital to work, etc. A lot of times it’s how the money is being raised. But you’re exactly right—there are a lot of question marks.

The firms usually have some type of a track record. If you see that they’ve raised this other fund, then it’s had a decent track record. Oftentimes, people say they’ll rely on the track record of a deal that they’ve done before. They’ll apply it and at least know what they’re doing. But to your point, we’re going to start somewhere. A lot of times, you’re going to be the first one.

[00:05:15] Dean Barber: Again, the concept behind the REIT is for the average investor to invest in either real estate for growth, which would be a portfolio that would have a fairly high amount of debt, or a real estate for income, which they would have a fairly low amount of debt and trying to kick off a decent dividend, kind of like a bond alternative. But they come in all kinds of shapes and sizes. There have been REITs from a historical perspective that have been wildly successful where people have made a lot of money.

Realto’s Purpose

On the flip side, some REITs have been a total flop. People have held them for eight, 10 years, and they’re still not liquid, They can’t get their money out of them. Maybe they have a flop, but haven’t come full cycle yet and sold the real estate. They haven’t made a public listing so that people can say they put their capital in. They have their dividends over the years, but they’re ready to get their capital back and want to deploy it somewhere else. That’s where Realto comes in. Tell us more about the opportunity you saw. What does Realto do?

[00:06:30] Brian King: Great question. There are a lot of products out there. These REIT structures have been around for five, 10, 12 years, and still haven’t had a liquidity event. Whether it’s circumstances of life or maybe the person who originally purchased that investment passed it on to an heir of some sort, those are all natural reasons why somebody would want to be able to have a liquidity event.

Otherwise, there’s just the natural element of wanting to reposition your portfolio. When you’re holding an investment for that long, it may or may not have been very successful. But the ability to say, I want to make a decision with this money, and in many cases, they don’t have the opportunity to make a decision with their money.

They’re beholden to the trust as to if they’re going to have a listing event on an exchange or if they’re going to have somebody that’s going to acquire them. Those are the two most natural events that happen in the life cycle. But if market conditions aren’t great for them, they just keep waiting. It’s up to the fund company to decide when they do it.

Defining Illiquid Assets

[00:07:57] Dean Barber: First, let’s explain why these assets are illiquid. Let’s say that 100 investors get together and buy a $2 million apartment complex. But one of the investors wants out. Well, you can’t just sell an apartment or carve some bricks off the side and sell those and give that investor their money out. The apartment needs to sell before there can be a liquidity event, or somebody else needs to come in and buy it, or they need to list it on an exchange. I think that’s where people get confused. They don’t understand why can’t they get their money out. It’s because their money is in an illiquid asset.

Real estate, by its nature, is an illiquid asset. In a way, it’s good because real estate sometimes takes time to mature and to do what you want it to do. That’s especially true when you think about the acquisition costs that come into purchasing real estate. Many people have purchased a home or have purchased some real estate in the past, and it’s not free. You have real estate commissions, lawyers’ fees, and all kinds of expenses to acquire that real estate. So, you might start out in a hole, 5%, 6%, 7%, 8%, 10% because of all the expense involved in acquiring that. The real estate needs to start appreciating in value for that investor to get their money back out.

There’s No Easy Button for This Process

[00:09:28] Brian King: That’s right. If you are using your analogy and there is cash available, then yes, you could say, “I’m going to buy your equity stake in this asset and do that.” The problem is it’s historically a very complicated procedure. One, you have to be able to value that asset.

Two, there’s a lot of paperwork that traditionally goes into doing that with transferring shares. It’s a very complicated, very paper-driven process. Most people that are managing funds, that’s not what they’re in it for. They want to limit the amount of liquidity because they don’t want to deal with changing shareholders. They would rather just use anybody who wants to invest in the fund continue to raise more capital.

[00:10:26] Dean Barber: I get it. There’s another reason that I believe that a lot of these REITs have not had a liquidity event. And the ones where you see where they’ve not had a liquidity event, it isn’t necessarily because the timing is wrong, but they’ve got an internal management fee on that thing, or they may be collecting 1%, 1.5%, 2% per year to manage the real estate and they don’t want to give up that cash cow.

Greed Can Easily Enter the Picture

[00:10:54] Brian King: Yeah, it’s the golden goose. And typically, once you list that on an exchange because those are more publicly known, those fees, you have to disclose it. Most people will then reduce their fee because it’s publicly listed from whatever that number is, 2%, 2.5% down to 1%, 1.5%.

[00:11:16] Dean Barber: Yeah. And so, there is something there where there’s a little bit of greed on the other side of it.

[00:11:20] Brian King: Yeah, they need to give something up to do it.

[00:11:23] Dean Barber: Right, yeah. And yet, there are ones that listed or they actually filled up, did what they said they were going to do, and two or three years later had a liquidity event and made a lot of money.

High-Frequency Trading in the World of Stocks

[00:11:36] Brian King: That’s right. I mean, you see a lot of success stories across the street. Just because something hasn’t had a liquidity event doesn’t mean it wasn’t successful. At the same time for us when creating an exchange for alternative investments, we’re not trying to make it so that these are trading like a stock. While they do trade as easily as a stock, we’re not trying to. There’s high-frequency trading that exists in the world of stocks today. My background comes from the exchange world. I know that market really well.

We’re not trying to make it so that these are being turned over multiple times in a day, but we want to have pools of liquidity that are available to somebody who wants to exit. There are institutional buyers and even retail buyers that would love to buy some of these positions.

McKinsey Group, CMG, and Comrit

[00:12:30] Dean Barber: Let’s talk a little bit about that. But before we get to that, I want to throw out the name McKinsey Group. Anybody who owns a non-traded REIT, it’s highly likely that you have received a solicitation from this McKinsey Group to buy your shares in a non-traded asset. Typically, when McKinsey Group is making an offer, they’re discounting at 50% to 60%. They know you need the money. So, in $10 a share, they’ll give you $4.50 today just so you can get out of it.

[00:13:07] Brian King: Right. So, there are three really well-known groups—McKinsey Group, CMG, and Comrit. If you own one of these assets, you received a letter from one of them.

[00:13:20] Dean Barber: And most of the time, that’s not a good deal.

[00:13:23] Brian King: Oh yes, that’s absolutely right. So, all these funds post an NAV (net asset value). Usually, it’s a third party that values that evaluates the value of the fund. Let’s say that the NAV is $10. Most of the time, the offer that you’re going to get is going to be around $5. So, it’s a 50% discount. Most people wouldn’t consider that to be a great deal.

[00:13:52] Dean Barber: Right. But they say there is no plan liquidity event for this. But if you want out, we’ll get you out now.

[00:13:58] Brian King: Right.

Finding the Real Value of REITs

[00:13:59] Dean Barber: What Brian has done with Realto is say, “Let’s make an exchange specifically starting out for these non-traded REITs for people that want to sell and for people that may want to buy.” Brian is diving in deep to the many non-traded REITs that are still out there today to determine their value. What’s the most recent appraisal, the cash flow, the occupancy, etc.? You can come to what’s the real value is that NAV close to that and then you’re going to say, institutional buyers, are you interested in this? And then how does all that work? Tell us how you put those two pieces together.

[00:14:42] Brian King: So, we have a lot of different institutional investors that want to work with us. They’re very interested in buying these assets. Some of the institutional investors we talk to would love to take down $50 million in this particular position. And that’s fantastic. But getting to the end investor, providing them information to let them know that there is a legitimate buyer out here, and in most cases, there is going to be some type of liquidity discount because the investor is going to have to hold it for a long period of time. There’s not an immediate opportunity for them to turn that asset around and sell the $50 million for the asset.

The Stock Market in Its Simplest Form

There still would be somewhere between a 10% and maybe 15% discount of that particular asset that the institution would want to have. But that’s obviously significantly different from a 50% discount. We have a fully electronic platform that allows an investor to see on the marketplace what current bids are out there. And if you say, “Hey, I’d love to sell it for that price,” you can sell it for that price. And if you say, well, I’d rather name my own price and create a limit order and say, if the prevailing bid on the screen is $9.50, you’re like, I’d rather get $9.60. Well, you can put your limit order out there and see if there’s another side of the trade that would come in and buy it for that price.

[00:16:09] Dean Barber: I don’t know that a lot of people think about the stock market this way, but if you think about it in its most simplistic form, it is supposed to be a means for an orderly exchange of shares. For every wannabe seller, there’s got to be a wannabe buyer. And so, when you say to a broker that you want to sell a stock, there needs to be somebody on the other side that’s willing to pay whatever price that stock is worth.

[00:16:41] Brian King: That’s right.

[00:16:42] Dean Barber: And they may not be. If somebody wants to buy and nobody else wants to sell, then they’re going to have to do something and maybe say you’d pay more. You’re creating an exchange that’s just like that, connecting the buyer and the seller that is separate from the stock exchange, but this is in exchange for alternatives.

BATS (and Not the Ones You See in Caves or Play Baseball with)

[00:17:04] Brian King: That’s right. I’ve spent most of my career in the exchange world. In the Kansas City area, a lot of people might know of a company that was a startup called BATS here in the area. I was one of the original guys to help build that and then moved over to Europe, built BATS Europe, moved back and started the ETF business for them, and then ultimately moved to the New York Stock Exchange.

Each time we built a new market, it was always a process of making sure that you’re bringing the buyer and seller. You’re helping to make sure that both sides of that transaction are there at all times. In the alternative space, this is a brand-new thing. There aren’t a whole lot of markets out there for alternatives, in general, and then especially there’s nothing out there for these real estate-related investments.

[00:17:48] Dean Barber: So, if a person says they like real estate, they could go to your exchange and see what’s out there. Can they offer to buy at the same price that the institutional investors are willing to buy it?

Transcending Transparency

[00:18:06] Brian King: Absolutely. We’re not limiting it to institutional investors. In fact, we like the idea of having it open to all investors. And that’s kind of our hope is to kind of break down some of the walls to say alternative investments should be for everybody. Part of our goal is to create additional transparency. Transparency comes around disclosures of information as well as price discovery to say that there’s a bid out there by McKinsey or somebody else at 50% discount. But there’s also this other institution that’s willing to pay a 10% discount. Maybe there’s an individual that was willing to buy something at a 5% discount. We love the idea of opening it up.

Using Barber Financial Plaza as an Example

[00:18:52] Dean Barber: I’m going to use a real-life example here. The studio that we produce The Guided Retirement Show™ in is part of a 24,000-square-foot office park that I own. We’re fully occupied. We have a net cash flow after expenses, etc., of around 6.5%. And let’s just say that ballpark, you got a $3 million appraisal on the property. You have a $3 million property that’s kicking off a nice 6%, 6.5% cash flow, but somebody could come in and offer me a 15% discount. So, they’ll buy it for $450,000 less than the $3 million. Well, what’s that going to do? That’s going to allow that individual to purchase it to immediately get a better cash flow than if they paid full price.

In essence, what you’re doing in that exchange is allowing the buyer to say, “Here’s the property, occupancy, rent rolls, and yield. I can buy that at a 15% discount. Now, I suddenly have immediate 15% equity on my purchase and I got a pretty decent cash flow.” In today’s really low-interest rates environment, that’s where your institutional investors come in and say, “Hey, we like this.”

Real Estate in a Yield-Starved Environment

[00:20:13] Brian King: Absolutely. That’s a very real-life scenario. Most of the buildings like this aren’t in a big REIT structure. REIT structures typically are just massive in size. A lot of these are $1 billion to $5 billion in size. But we also are going to be rolling out the ability to put a single-asset LLC on the platform in the very near future if somebody wants to de-risk themselves. Let’s say they currently own an asset that’s $5 million in value, but would love to offer it out to somebody. They’ll take half of their skin out of the game and put it out there on a market.

Let people decide if that is something they want to invest in. We’re in a still pretty yield-starved environment, so real estate does a fantastic job of providing yield in somebody’s portfolio.

Real Estate Is Like a Bond on Steroids

[00:21:11] Dean Barber: I always think of real estate if it is purchased properly. Real estate really acts like a bond on steroids. You get the yield and you get some price appreciation over time, hopefully. Obviously, we know it doesn’t always work that way. What we’re going to do is think back to the 2008 financial crisis. We know that real estate doesn’t always go up.

[00:21:29] Brian King: That’s right. And then, of course, one other thing that real estate often offers is also tax benefit. Most real estate structures offer some element of tax incentives or benefits.

The Necessity of Connecting Buyers and Sellers

[00:21:42] Dean Barber: At what point did you realize that this need was out there to connect the buyers and the sellers, the wannabe buyers to the wannabe sellers? And at what point did you do that? How long has Realto been operating? Tell us a little bit more about that.

[00:21:59] Brian King: Sure. I mentioned earlier that along my career path, I spent about five years in the New York Stock Exchange. When I was at the New York Stock Exchange, it was pretty interesting that the number one competitor that they had wasn’t another exchange; it was the private markets. Everything that they were doing felt like they were fighting to try to make more companies, more products come into the public environment. That’s how they make their money. They haven’t made a lot of investments into the private environment. That was a constant battle.

Private Markets’ Biggest Hurdle: Liquidity

Sitting within that organization, I could see how much the private markets were growing. The private markets are fantastic, but the biggest hurdle that they have is liquidity, generally.

I mentioned earlier that there’s been a lot of growth in secondary markets for corporations, whether it’s second market, which NASDAQ ultimately bought or SharesPost or Forge. All those different types of companies have come out to try to create secondary markets for that. I saw that and realized there is a big opportunity here. The real estate market is $10-plus trillion in the U.S., so the opportunity to address that is pretty significant.

How Realto Came About

Then, I met up with my co-founder, Jeff Kinney, who also lives in the Overland Park area. He and I started generally talking about real estate investments. I said to him, “You understand the alternatives world way better than I do. You understand alternatives and real estate, different structures, etc. If we were to think about the possibility of creating an exchange-like mechanism, do you think that that would make sense? Do you think that’d be possible?

We had that conversation at the beginning of 2020 right before the pandemic kind of set in. He was like, “Absolutely. If you would have asked me that question two years ago, technology was so far behind in the alternative’s world. We probably couldn’t have done it because there are things, historically, like medallion signature guarantees. If I want to transfer an asset to you, historically, you had to go into a bank, get a wet stamp, sign it, etc. based on certain technology. Fast forward now and the pandemic really helped it. That sounds weird to think that the pandemic helped something.

[00:24:23] Dean Barber: The pandemic sped up the adoption of technology light-years.

[00:24:27] Brian King: Absolutely. We could leverage that and we spent 2020 kind of building the idea, the concept, how it would work, etc. We spent the latter part of that year raising capital to fund the business. Then, we officially launched in 2021.

A Marketplace for Private Debt and Private Equity?

[00:24:44] Dean Barber: Awesome. That’s a great thing. You talked about the private markets and you hear people talk about private equity or about private debt. Typically, private equity and private debt have been exclusive to the institutional investors. Are you planning on making a marketplace for private debt and for private equity? Is that something that is on your radar?

[00:25:19] Brian King: Absolutely. We’ll be launching our private market capabilities later this year. We are going to start in the real estate end of that spectrum. But once we have that solved from a real estate perspective and we launch it, there’s very little that we have to roll it to other asset classes. We want to stay focused initially. It makes a lot of sense to focus on one particular asset class, but absolutely, other types of private investments, private debt, etc., we’ll definitely roll into.

Retirees Seeing the Worth of REITs

[00:25:55] Dean Barber: Awesome. We’re going to put some links in the show notes to your website and some things where people can learn more. It’s great to have entrepreneurs on The Guided Retirement Show™. I know there are a lot of people that are retired that have these non-traded REITs. They might see what it’s worth.

And all they need to do is get with their advisor, especially if they’re here at Modern Wealth Management. We can hop on your exchange platform and say, “Is this one on there? Can we sell it? If so, what are we offering?” I encourage people to check it out, especially you know somebody that has these things. Check out the data that’s in the show notes. It’s been great having you on here, Brian.

[00:26:40] Brian King: Awesome. It’s great to be here. Thank you so much for having me.

[00:26:42] Dean Barber: You bet. Thanks so much for joining us on The Guided Retirement Show™. I’m Dean Barber. We appreciate you joining us. Hopefully, you enjoyed my conversation with Brian King. As a quick reminder, get out to the show notes, check out the website. If you want to visit with one of our certified financial planners, you can click a link there as well and schedule a meeting with one of our CFP® professionals. Thanks again for joining us on The Guided Retirement Show™.

[END]