In recent periods, a number of prominent non-traded real estate investment trusts (REITs)1 disclosed that repurchase requests from stockholders under their share repurchase plans exceeded monthly or quarterly repurchase limits and that, as a result, all repurchase requests were not satisfied.2 This alert looks at the different types of current non-traded REIT share repurchase plans and at some potential improvements in the liquidity feature that may be adopted by non-traded REITs in the future.
Share Repurchase Plans Overview
Non-traded REITs at their core wrap an illiquid real estate portfolio into an illiquid securitized container, with no market-clearing mechanism to adjust supply and demand. Share repurchase plans are offered by many non-traded REITs to provide investors with a measure of liquidity from time to time. Under these plans, stockholders can periodically request that the non-traded REIT repurchases all or a portion of their shares. For those non-traded REITs that calculate a monthly net asset value (NAV) per share, repurchases under the share repurchase plan also typically take place on a monthly basis and at a price per share generally equal to the prior month’s NAV for the relevant class. For those non-traded REITs that calculate a daily NAV, repurchases can take place on each business day at the NAV for the relevant share class as calculated after the close of business on that day. As a result, for non-traded REITs that have daily repurchases, at the time an investor submits a repurchase request, they will not know the exact price at which the order will be executed. Share repurchase plans also often subject repurchases to short-term trading discounts (e.g., if the shares are held for less than a year, they will be redeemed at 95% of the applicable NAV per share).
There is no legal requirement, however, that a non-traded REIT offer a share repurchase plan in the first place. Rather, these plans are generally offered to provide the opportunity for limited liquidity to enhance the marketability of non-traded REIT shares. Indeed, even if a share repurchase plan has been adopted, a non-traded REIT is not obligated to repurchase shares under the plan and may choose to repurchase only some, or even none, of the shares that have been submitted for repurchase. The non-traded REIT’s board of directors typically also has the unilateral power to suspend the share repurchase plan at any time at its discretion.
When adopted, share repurchase plans are structured by non-traded REITs so that they are not deemed a “tender offer” under the federal securities laws. In a series of no-action letters, the SEC staff has advised that imposing quarterly limits on aggregate repurchases is an important component in ensuring that share repurchase plans do not run the risk of being deemed illegal tender offers.
Pursuant to the SEC guidance and accepted market practice, aggregate repurchases under share repurchase plans are typically capped at up to 5% of NAV per calendar quarter, with some plans also restricting monthly aggregate purchases to 2% of NAV. For some non-traded REITs, if plan repurchases for a month or calendar quarter (net of proceeds from sales of new shares) do not reach the 2% limit or the 5% limit, respectively, the unused portion will be carried over to the next month or quarter, subject to certain limits.
There are differences in approach among plans for how repurchases are handled if the repurchase limit is reached, though virtually all plans incorporate some form of pro rata allocation and cut back. For some non-traded REITs, the plan provides that at overcapacity, all requested share repurchases will be cut back pro rata by shareholder for the relevant period. All unsatisfied repurchase requests must then be resubmitted after the start of the next period. For other non-traded REITs, if net repurchase requests reach the limit, then proration is applied to open repurchase requests on the day the limit is reached, and no other repurchase requests for the rest of the period are accepted. However, to alleviate pressure and create some fairness, when the REIT begins accepting repurchase requests again on the first business day of the next period, it applies the applicable limit on a per-stockholder basis, instead of a “first-come-first-served” basis. The “dampening” effect of the per-stockholder limit remains in effect for as long as available liquidity remains constrained relative to demand for liquidity.3 In these “flow-regulated” systems, the REIT effectively wipes the repurchase queue clean each period and starts with a clean slate the next period. Likewise, these systems are generally entirely democratic: each stockholder is ensured the ability to redeem an equal portion of its investment on the same terms relative to all other stockholders.
While the technical details of share repurchase plan mechanics can be complex, a way to understand it is to think of the difference between the orderly process of passengers getting off an airplane at the gate versus the mass evacuation of a crowded stadium. On a plane, there is typically one aisle, and the only choice is for everyone to stand up and queue for an orderly exit. Anyone who travels knows how frustrating this process can be — but everyone eventually makes it off the plane. In a stadium, when the crowd rushes for the exits, there are few ways and little time to prevent a stampede. This is because flow through volume at the limited number of exit points, whose size is fixed, cannot be increased ad hoc. As previously noted, non-traded REITs wrap an illiquid real estate portfolio into an illiquid securitized container with no market-clearing mechanism to adjust supply and demand. So a “run on the bank” can create stampede-like conditions unless some form of orderly exit mechanism is put in place and enforced. That is the goal of the proration provisions of typical share repurchase plans.
The Costs and Risks of Share Repurchase Plans
Shares in non-traded REITs represent an interest in an illiquid portfolio of real estate assets, so liquidity cannot be a guarantee — but it also must be more than an aspiration. Access to liquidity should ideally rest on a robust foundation that minimizes the risk of a liquidity crisis given the unpredictability of inflows and outflows. That foundation should include:
- A layer of liquid assets to bridge a temporary mismatch between inflows and outflows
- Access to committed liquidity lines of credit if the imbalance persists in the short term
- Sufficient runway to evaluate liquidating real estate assets in an orderly manner if pressure from foreseeable repurchase requests builds up in the medium term
- Enough visibility to pursue a strategic exit in the long term via a merger or liquidation
Each of these features can be measured using two parameters: cost and time. In a perfect structure, the two would be blended in a continuous, seamless curve to reduce volatility, minimize impact on total return to stockholders, and ensure maximum reliability of the repurchase feature. In the real world, non-traded REITs are vulnerable to market volatility and cyclical spikes in the cost of liquidity. In recent years, most non-traded REITs have not experienced true liquidity squeezes because stockholder requests have been limited over this period and have stayed within a REIT’s ability to easily satisfy them. The cost of liquidity has instead essentially been amortized over the entire equity capital structure and blended into operating expenses without significantly depressing NAV.
More current developments, however, remind us that non-traded REITs need to be prepared for periods of liquidity pressure. Liquidity requests at any level negatively affect total return and interfere with optimal portfolio construction. As more investors seek to access liquidity, possibly at an accelerating pace during times of stress, available liquidity resources are depleted, leaving a choice between increasing leverage (to the extent unsecured or secured financing is available) or forcing unanticipated sales of assets. In times of extreme demand for liquidity, a suspension of repurchases may be the only way to protect the balance sheet. A liquidity squeeze poses difficult challenges for sponsors and directors, who are charged with protecting the interests of all investors rather than allowing those investors who run for the exits first to harm those who are patient or unaware of building pressure.4
In the United States, modern non-traded REITs have experimented with a few devices to make liquidity stress bearable. As noted above, some non-traded REITs provide that if net repurchases in a calendar quarter reach the repurchase limit, then the REIT will begin accepting repurchase requests again on the first business day of the next calendar quarter, but will apply the repurchase limitation on a per-stockholder basis instead of a first-come-first-served basis. This means that at any time during that quarter, each stockholder will be able to redeem a portion of the stockholder’s investment on the last business day of the preceding quarter. The per-stockholder limit will then remain in effect for the following quarter if total net repurchases reach a certain threshold during the quarter.
However, many of today’s non-traded REITs have less robust repurchase plans in place for operation during a time of stress, which could potentially reward investors trying to game the system to their advantage. That could further destabilize the situation and cause grievous harm to investors who are not as well advised or are simply “doing the right thing.” As previously noted, these repurchase plans may incentivize investors to supersize their repurchase request during a liquidity squeeze so they at least get their pro rata share. Non-traded REITs typically have the option of completely suspending repurchases, but most likely do so at a great reputational cost. As the UK open-ended property fund experience has shown, once pressure builds there are no safe choices:
- Shutting-down is a blunt instrument that shocks investors, no matter how clear the disclosure of illiquidity risk was in offering documents.
- Prorations and gating tools are rarely seen as treating all investors fairly and equitably.
- Spreads between entry NAV and exit NAV can be arbitrary and are fraught with unintended consequences.
We have come to believe that there is a better way.
A Better Liquidity Structure: Let Stockholders Choose
It is intuitive that liquidity is a benefit, and benefits have costs. The cost of liquidity in the non-traded REIT structure is the dilutive effect on investment returns from keeping liquid reserves and/or semiliquid assets in case of redemption pressure beyond the netting of equity inflows and outflows. In the current model, all stockholders bear a portion of the cost of liquidity whether they need the benefit or not. Additionally, all stockholders bear the contingent risk of a run on the bank including, in a worst-case scenario, pressure on the REIT to liquidate real estate assets in a hurry at the wrong time to fund repurchases.
However, many investors in modern non-traded REITs do not want or need the ability to redeem their shares on demand—their time horizons are part of their capital allocation model. However, these investors are forced to bear a share of the cost of daily or monthly liquidity on demand, which inevitably means lower total returns because the REIT either holds more liquid assets at a low yield to meet unexpected repurchase requests or subsidizes repurchases for investors with the near-term expectation of liquidity by making suboptimal portfolio construction choices. So why not allow stockholders to choose how much liquidity they want, and then charge them a fair price for that level of liquidity only, while charging those who want maximum liquidity the cost of liquid or semiliquid reserves?
This could be done through differentiation in the repurchase feature among different classes to better match availability of liquid assets to fund repurchases with the expected timing of repurchase requests. This matching could be done without the disruption of suspensions, queuing, or gating. In current market practice, there are already prenegotiated differentiations in the economic terms between different classes of common stock in the same non-traded REIT. These differences typically relate to different fee levels and blends of front-end or back-end loads, which are reflected in a slightly different NAV per share for each series of stock. We would propose adding to the differentiating class traits additional features that relate to access to liquidity under the share repurchase program.
For those investors who want enhanced liquidity rights, their class of shares can feature relatively shorter notice periods, higher limits on volume of repurchases per period, and even preferred access to the “front of the line” vis-à-vis other classes. Conversely, for those investors for whom enhanced liquidity rights are not critical, their class of shares can feature relatively longer notice periods, lower limits on volume of repurchases per period, and even subordination in liquidity access to the more liquid classes. The different liquidity rights among the classes would likewise be reflected in the NAV per share for each class and/or variations in dividends.5
For example, subclass X of a non-traded REIT’s common shares could allow for daily or monthly repurchases subject to current flow-regulation mechanisms (“Tier One liquidity shares”); subclass Y could allow for repurchases only to the extent that inflows or flow-regulation mechanisms allow (the “Tier Two liquidity shares”), and subclass Z could allow for repurchases only with a long notice period on an annual or biannual basis (the “Tier Three liquidity shares”). Tier One shares would offer lower total returns, through the dividend rate or through a lower NAV, to account for the cost of on-demand liquidity as measured by the drag on returns of keeping cash available or the financing costs of liquidity lines. Tier Two shares would offer a medium total return on account of the foreseeable impact of rebuilding the liquidity buffer, including the cost of unplanned sales of assets to relieve pressure on the “ordinary” repurchase queue if imbalance persists. Conversely, total return on the Tier Three shares would be closest to the “natural” return on assets of the real estate portfolio because they would not bear drag on returns from maintaining on-demand liquidity buffers.
If desired, the non-traded REIT’s charter could provide that each subclass could be exchanged for a higher or lower liquidity subclass on a forward basis (possibly with the same notice requirement of Tier Three shares to prevent arbitraging). The same penalties currently in place at many non traded REITs to discourage frequent trading could be extended to prevent frequent exercise of the exchange feature to game the “staggered liquidity” structure.
With the recent focus on repurchase plans and a variety of institutions contemplating entering the non-traded REIT space, we expect to see more variation in the liquidity feature going forward. The structuring devices outlined above would allow modern non-traded REITs to better anticipate the foreseeable volume of repurchase requests, plan their liquidity buffers accordingly, and ultimately optimize asset management.
 For the purposes of the alert, when we refer to a non-traded REIT, we are referring to a REIT that registers its offering of common stock under the Securities Act of 1933 on Form S-11, files reports with the SEC under the Securities Exchange Act of 1934, and is not listed on any securities exchange or other trading platform.
 The Wall Street Journal recently highlighted the spike in redemption requests and the perils of non-traded REIT share repurchase plans. Gottfried, M., Grant, P. and Feng, R. (2023, February 12). Blackstone’s Big New Idea Leaves It Bruised. Wall Street Journal. https://www.wsj.com/articles/blackstones-big-new-idea-leaves-it-bruised-d66de361?st=dhwua9u2xjj037z&reflink=share_mobilewebshare
 The per-stockholder limit is particularly effective when larger stockholders (or multiple stockholders acting together under the advice of investment advisers) might cause pressure to build very quickly in a new cycle by submitting more shares for repurchase than they actually want to have repurchased because they expect the request to be prorated.
 One does not have to look far to be reminded of how dangerous the pressure side of liquidity can be: The regulated open-ended property fund sector in the United Kingdom has repeatedly faced crisis conditions (the fallout from the Brexit vote being an extreme case in recent years) because liquidity is mandated by law for all investors, and waves of excessive repurchase requests made the structure seize up.
 The willingness to accept higher returns for reduced liquidity in the non-traded REIT space was recently demonstrated in the first-quarter 2023 acquisition by the Regents of the University of California of an aggregate $4.5 billion of common shares in Blackstone Real Estate Income Trust, Inc., in which the Regents agreed to an effective six-year hold period in exchange for a preferred return supported by Blackstone, Inc. See “UC Investments Creates Strategic Venture with Blackstone to Invest $4 Billion in BREIT Common Shares” and “UC Investments to Invest Additional $500 Million in BREIT Common Shares“ from Business Wire. (Note: Goodwin represented the Regents in these transactions.)