Wells Foregoes Fee on REIT II

On June 29, The Rational Realist reported that Wells REIT II had announced that it will not pay to internalize its advisor.  This is a big deal, as the internalization fee was the big payday for a syndicator, and it wasn't subject to such uncontrollable factors as performance.  Wells Real Estate Funds is forgoing probably between $150 and $200 million.

This is not an altruistic move.  Leo Wells is a very charitable man.  However, he is very quick to tell you that Wells Real Estate is not a non-profit organization. 

Nor is this an indication of some newfound backbone by the Board of Wells REIT II.  REIT boards are filled from a good ole boy network, and Leo Wells is the definition of a good ole boy.

Forgoing the internalization fee is the second move that the wells organization is taking to address an issue tat is much bigger to Leo Wells: slumping sales.  at its core, Wells Real Estate Funds is a sales organization, not an investment organization, not a real estate organization.  Every decision is made through a lens pointed at sales trends.  Wells Timberland's capital raise was an enormous disappointment.  The raise for its Mid-Horizon Value-Added fund has been lackluster.  Core Office REIT was on a run rate of about $1 million per day raising just $225 million through December 31, 2011 and $282 million through March 31, 2012.  In May, Wells made wholesale changes in its senior sales personnel.  Now, Wells II has reduced its fees.

What has not happened is the renunciation of internalization fees for the Core Office REIT.  I guess Wells is hoping that the market will pick up the implication that no more internalization fees will be charged.  Their market prospects would improve much more significantly if the Core Office REIT would just adopt that position.

Wells Settles With FINRA

In April, I wrote a note about Wells Investment Securities coming under scrutiny from FINRA for sales materials related to the Wells Timberland REIT offering.  Investment News had an article last week that appears to report on the conclusion of that investigation.  Wells has been fined $300,000 in conjunction with a letter of acceptance, waiver, and consent related to what FINRA describes as false and misleading marketing materials.  The dispute revolves around the fact that the Wells Timberland did not qualify to be treated as a real estate investment trust until December 31, 2009, and that Wells Timberland held only one property despite stated objectives of diversification.

I am not a Wells apologist, but I think that Wells is the victim of an overly aggressive regulator.  I am familiar with all of the marketing material supporting the timberland offering, nearly from its inception.  It was clear that the the REIT held only the Mead-Westvaco property, and that any diversification would be dependent on raising additional capital, and a lot of it at that.  And the prospectus and financial statements files with the SEC stated frequently that Timberland had not yet qualified a a REIT.  This is a case of failure to execute a business plan due to undercapitalization, not a misstatement of the business plan. 

I think that Wells suffered a little bit from its prior dealings with NASD.  Wells has a history with the regulator, and I think that history had an effect on FINRA's position and its willingness to negotiate.IN this case, it's a shame because it appears that Wells was trying to remain true to its business plan, while executing prudent tactics.

Wells REIT II Valuation

Wells REIT II sent a letter to investors with an updated share valuation.  At $7.47 per share, the new value reflects a significant decline from both the offering price of $10.00 and the DRIP price of $9.55.  It is also notably lower than the estimate share value estimate I gave in an earlier post.

Wells is due some credit for accepting the consultant's valuation unmodified.  The REIT was formed and was making significant acquisitions during a real estate market that was much more robust than current conditions.  Valuations are bound to be lower than par, given the legacy properties in the portfolio.

Unfortunately, the new valuation is also consistent with investor experience with Wells programs.  Investors receive an attractive income stream, but then are subject to a negative surprise on a revaluation or liquidity event.

Special thanks to the Rational Realist.

10K Season - Wells

Financial reviews continue.  I have run a basic financial statement analysis on the most recent Wells offerings – Wells REIT II, Wells Timberland REIT, Wells Hid-Horizon Value-Added REIT, and Wells Core Office Income REIT.

In  Thousands	Wells REIT II	Wells Mid-Horizon Value-Added	Wells Timberland	Wells Core Office Income
Total Assets	$5,371,685	$63,242	$360,491	$35,421
Total Liabilities	$1,754,452	$20,974	$199,931	$18,877
Equity Raised	$3,455,697	$51,854	$240,000	$20,548
Net Real Estate	$4,230,039	$50,178	$340,504	$27,994
Direct Debt	$886,939	$19,000	$168,841	$17,275
Leverage Ratio	21.0%	37.9%	49.2%	61.7%
Revenue	$567,967	$5,570	$47,582	$755
Net Income	$23,266	$3,420	($19,518)	($1,544)
FFO	$243,176	($16)	($5,180)	($1,203)
Mod Cash Flow[1]	$254,116	($16)	($1,471)	($534)
Dividends	$300,719	$0	$0	$127
Yield ($10 share, $1,000 unit WMHVA, $25 share Core Office)	5.7%	0.0%	0.0%	1.0%

Wells Real Estate Trust II closed its offering in June 2010.  At December 31, 2010, the REIT had $5.4 billion of assets including $4.2 billion of real estate owned directly.  Wells REIT II realized $568 million total revenue and a $23 million net income.  The shareholder 5.7% dividend is 80% covered by Funds from Operations and 85% by Modified Cash Flow.  The company realized a $161,000 loss on the sale of New Manchester One during 2010.  The REIT appears to be managing its cash flow prudently, covering distributions at a 90% rate.  Property operations in 2010 capitalized at a 7.5% rate suggest net real estate value of $5.9 billion, approximately 40% higher than the book value of the real estate.  Such a value would be consistent with a value of about $9.50 per share, very close to the DRIP price.

Wells Mid-Horizon Value-Added Fund, LLC, opened its initial offering in September 2005 and closed it September 2008.  At December 31, 2010, Timberland had $63.2 million of assets including $50.2 million of real estate owned directly.  Wells Value-Added Fund realized $5.57 million total revenue and $3.4 million net income after recognizing a $6.7 million gain on the disposition of the Park Lane Building in Pittsburgh, PA.  The REIT’s book value per share was $812.85 as of December 31, 2010, which reflects a decline from the original $1000 offering price per unit equal to the offerings costs and deprecation recognized on the real estate holdings.  The REIT originally had an objective of liquidation of the portfolio within eight years of the start of the offering of units.  This would suggest a termination in 2013.  However, the 10-K appears to be preparing investors for an extended holding period: “(W)e do acknowledge that the current economic conditions and their impact on office market conditions may require that we hold individual assets longer than originally projected in order to achieve the best disposition pricing for our investor members.”

Wells Timberland REIT opened its initial offering in August 2006 and its follow on offering ion August 2009.  At December 31, 2010, Timberland had $360 million of assets including $341 million of timberland owned directly.  Wells Timberland realized $47.6 million total revenue and a $19.5 million net loss after provision for $3.7 million of preferred dividends, which were deferred.  Shareholders currently receive no distributions.  The REIT’s book value per share was $4.16 as of December 31, 2010, which represents a significant dilution from the $10 offering price.  As of the publication of the REIT’s 10-K, the share offering is scheduled to close August 6, 2011.

Wells Core Office income REIT opened its offering in June 2010 and is raising funds at a reasonable pace.  At December 31, 2010, the REIT had $35.4 million of assets including $28 million of real estate owned directly.  The company generated $755,389 total revenue and a $1.5 million net loss.  The shareholder 1.0% dividend is not covered by Funds from Operations or Modified Cash Flow.  The subsidy of dividends at this early phase of the capital raising is common.  As the REIT has less than a year of operations, it is too early to draw any conclusions on the effectiveness of management.

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[1] Modified Cash Flow is a Clarity Finance measure which equals (1) net income plus (2) depreciation and amortization, plus (3) acquisition fees and expenses, less (plus) (4) any realized or provisions for capital gains (losses) on the income statement, less (plus) (5) income (losses) from unconsolidated entities, plus (6) distributions from unconsolidated entities.

FINRA is Looking into Wells ... Again

On April 10, Investment News had a note that FINRA had made a preliminary decision to recommend disciplinary action against Wells Investment Securities.  The information was contained in a SEC filing by Wells Timberland REIT.  The REIT reported that:

On August 25, 2010, the Enforcement Department of the Financial Industry Regulatory Authority, Inc. (“FINRA”) notified Wells Investment Securities, Inc. (“WIS”), the dealer manager for the initial public offering of common stock of the Registrant and for the Registrant's current follow-on offering, that FINRA had made a preliminary determination that disciplinary action be brought against WIS for (1) using various sales materials related to the Registrant's public offerings that allegedly failed to comply with the content standards of FINRA's advertising rules, (2) allegedly failing to implement its supervisory system in an effective manner in order to achieve compliance with FINRA's advertising rules, and (3) allegedly failing to maintain written supervisory systems and procedures that were reasonably designed to safeguard customer information. FINRA stayed its August notification and requested additional information from WIS regarding its investigation. On March 1, 2011, the FINRA Enforcement Department notified WIS that FINRA had made a preliminary determination to recommend that disciplinary action be brought against WIS for allegedly failing to inform FINRA that the board of directors of the Registrant approved the deferral of the Registrant's election of REIT status, which was done in connection with its acquisition of the Mahrt Timberland in 2007. FINRA also proposed a censure of WIS and a fine. Before FINRA seeks authorization to issue a formal complaint, WIS has the opportunity to provide a statement to FINRA indicating why no disciplinary action should be brought. WIS intends to make such a submission responsive to the issues raised in both the August 2010 and March 2011 notifications on or before April 11, 2011. WIS intends to vigorously defend these charges.

Wells Core Office REIT made a similar filing.

This is the third time that Wells' sales practices have been questioned by FINRA.  In March 2001, Wells entered a written undertakings that it would not violate compensation regulations in conducting sales and due diligence conferences.  In August 2003, Wells consented to sanctions relating to the improper conduct of sales and due diligence conferences.

Wells is a very aggressive sales organization.  That aggressiveness has brought success in raising capital.  Unfortunately, the returns on that capital have been spotty, as a review of Wells' record in liquidated properties and full cycle programs would attest.