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Portfolio > Alternative Investments > Real Estate

Schorsch’s Issues Extensive but 'Isolated,' Says Nontraded REIT Expert

By Jada Smith

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Nicholas Schorsch and others who built American Realty Capital Properties (ARCP) — along with investors and employees — are, needless to say, having a pretty challenging holiday season.

But that doesn’t mean the nontraded REIT industry deserves coal in its stocking, says Kevin Gannon, president and managing director of Robert A. Stanger, which specializes in real estate investment banking.

“This is a challenging time for ARCP, and we have followed them closely for years,” Gannon said in an interview with ThinkAdvisor.

ARCP reported that it had accounting errors of $23 million in late October. Several executives then left the firm, and now one is accusing former-Chairman Schorsch of knowing about the errors that were pinned on her and ex-CFO Brian Block in a lawsuit filed on Dec. 18 in New York.

“This seems to be isolated to one entity,” said Gannon. “Many companies [in this business] have pretty good reputations.”  What nontraded REITs do is fairly “basic,” he explains. “They collect rent and pay expenses.”

While the accounting can get complicated at times, “There are accountants and regulators everywhere,” added Gannon. “Maybe the company was just growing too quickly and got ahead of its skis.”

In ARCP’s case, the fallout — in terms of sales and lawsuits — is likely to be extensive, experts say. In November, for instance, equity raised from investors at ARCP’s Cole Capital unit fell to $19.7 million, a drop of 81% from October, according to Robert A. Stanger; and American Realty Capital-branded real estate products raised $154.3 million, a 58% decline from October.

Members of the Investment Program Association, which represents nontraded REITs, “believe the complexity of the ARCP situation is really unique to that entity,” CEO Kevin Hogan said in an interview. “We do not see it as systemic to the rest of the industry … it’s a company-specific issue.”

Other nontraded REIT-industry watchers, however, see the situation more negatively.

“Whether the allegations are true or not, investors should appreciate the meaning and value of diversification,” said Brad Thomas, editor of “The Intelligent REIT Investor,” in an interview.

“If the allegations are true, the credibility of the whole industry [would be] in question,” Thomas said. “This is already in play, in my opinion … it’s a reality check.”

Weathering the Storm

In Gannon’s view, though, financial and other controls at companies like ARCP are generally sufficient if personnel in the accounting department have “backbones.”

“You have to have people who are able to protect shareholders, who have the ability to stand up and risk their jobs,” he explained. “They either have this or they don’t. You can’t teach it. But it’s bad, if that doesn’t exist.”

The real-estate investment expert says, in fact, it is “rare not to see folks like this in the business, because the financial markets and the regulatory environment are aggressive,” Gannon stated. “When there’s a sense that something is wrong, people stomp their feet on it.”

“This is all emanating from the fact that no one could stand up … and correct the error,” he said. “There’s no justification for not fixing it, unless it’s something like $0.50 on a $20 million account.”

As for ARCP’s relationship with its investors, “I hope they are on the right path,” Gannon explained. “They have to get over some bumps in the road … [With the drop in the share price] the bottom line is that they have eroded a lot of value creation for investors.”

Gannon, who says he used to speak with Schorsch once a week when ARCP was getting off the ground, says the situation caught him completely off guard.

“I found Schorsch and others at ARCP generally to be straight shooters,” added Gannon. “This is an anomaly from my experience. But it takes your breath away … the caution flag is up. I hope they can weather this storm.”

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