The changing regulatory landscape and continued bull markets in the commercial real estate property and debt markets have driven some significant shifts in the nontraded alternative investments industry over the past few years. Uncertainty around the U.S. Department of Labor’s Fiduciary Duty Rule and Financial Industry Regulatory Authority (FINRA) Regulatory Notice 15-02 caused the nontraded REIT industry to reassess fee structures and introduce greater transparency — changes intended to benefit investors and create a more level playing field.

Institutional money managers have taken note of these changes, which align the industry more closely with institutional structure, and have stepped into the private wealth market. Pricing appreciation in the loan markets provides limited opportunities for business development companies (BDCs) to invest in leveraged loans, resulting in a shift toward interval funds that provide for a more flexible investment structure. Commercial real estate pricing appreciation has resulted in the resurgence of the 1031 exchange market, which was all but dead in the water immediately after the recession. Here is a summary of some of the key trends in the nontraded market segments during the past five years.

NONTRADED REITs

Nontraded REIT sales slipped again in third quarter 2017 to $1.2 billion, with about one-third of this raised by BX REIT Advisors (Blackstone Real Estate Income Trust). The industry is poised for its slowest capital raise year in more than a decade. Nontraded REITs had raised about $4.3 billion year-to-date as of Sept. 30, 2017, about 8 percent lower than the $4.6 billion raised as of Sept. 30, 2016, and well below the $17 billion raised as of third quarter 2013. Interestingly, investment sales volume was down even in the institutional space, with Jones Lang LaSalle reporting investment sales growth down 8.8 percent as of Sept. 30, with a forecast decline of 10 percent for the full year 2017.

$2.7 billion of this year’s nontraded REIT raise comes from the 24 funds currently raising capital, while the remaining $1.9 billion comes from the roughly 70 closed programs that continue to raise capital through distribution reinvestment programs.

As of Sept. 30, 2017, Blackstone Real Estate Income Trust led the pack in terms of capital raise, having raised more than $1.25 billion year-to-date, representing just under half of the capital raised in the industry. Blackstone put the money to work as it was raised, acquiring 18 properties across several real estate sectors at a cost of $2.4 billion, along with $643 million invested in 24 CMBS holdings. The next closest competitor, Carter Validus Mission Critical REIT II, raised $292 million and acquired 15 real estate properties for an aggregate purchase price of about $458 million.

The 24 actively raising nontraded REITs manage about $14.1 billion in assets as of Sept. 30, 2017, compared with the roughly $2.0 trillion of commercial real estate assets owned by the 225 traded REITs in the FTSE NAREIT All REITs Index. In looking at the composition of the nontraded REIT industry, about 35 percent of the assets under management fall into the diversified segment, which is very different from the traded markets, in which diversified REITs comprise about 6 percent of the total FTSE NAREIT market cap. The largest component of the FTSE NAREIT index is the retail sector, at 16 percent of market cap. As of Sept. 30, 2017, no actively raising nontraded REITs were focused specifically on retail.

Distribution yields paid by nontraded REITs have declined from an average of 6.17 percent in 2012 to an average of 5.81 percent as of Sept. 30, 2017. This decline makes sense given average cap rates for commercial properties have declined steadily over this time period — anywhere from 1.0 percent to 3.0 percent depending on the industry, according to Real Capital Analytics. Nontraded REITs still boast a higher average distribution rate than public REITs, which averaged 4.17 percent as of Sept. 30, 2017.

Nontraded REITs have seen largely no change in their debt ratios over the past five years. The industry average, including actively raising and closed nontraded REITs, has ranged between 35 percent and 45 percent over this time period, and was at 44.04 percent as of Sept. 30, 2017. This is similar to the traded markets, which posted a debt ratio of 41.2 percent. The average interest rate on debt has declined about 80 basis points over the past five years, from 4.61 percent in 2012 to 3.81 percent as of Sept. 30, 2017.

The nontraded REIT industry has faced significant challenges in the past few years, including the uncertainty around the DOL’s fiduciary rule and FINRA’s account statement rule. Despite the slow capital raise and challenges over the past couple of years, the recent entrance of institutional money managers into the space suggests the nontraded REIT industry is positioned for a comeback — maybe not to the staggering levels of the ARC days, but higher than the past few dire years. While many of the existing nontraded sponsors filed funds for registration in 2017, including Hines, Griffin Capital Co. and KBS, new entrants to the space during the year include Nuveen (Nuveen Global Cities REIT), Starwood Capital Group (Starwood Real Estate Income Trust) and Cantor Fitzgerald (Rodin Income Trust), in addition to Blackstone’s registration in 2016. The entrance of institutional managers into the space, along with changes made to increase pricing and transparency, helps to solidify the industry as a valid method of raising capital to build real estate portfolios — a boon for existing and new managers, and hopefully a sign of better times to come.

NONTRADED BDCs

Following a similar pattern to the nontraded REIT industry, nontraded BDC sales slipped in third quarter 2017 as well, with eight active and 10 closed funds raising $301.1 million for the third quarter and $1.08 billion year-to-date as of Sept. 30, 2017. This is behind the 2016 pace and well below the $5.0+ billion pace in 2014 and 2015.

Nontraded BDCs have faced some of the same challenges as the nontraded REIT industry, although part of the slowdown may be attributed to fewer opportunities for investment as the market recovered, as well as signs of potential overheating. In addition, several sponsors who have offered nontraded BDCs in the past have opted to convert to a more flexible closed-end interval fund structure. This structure allows a manager to invest in levered loans as well as other investments as the market shifts. Griffin Capital’s Institutional Access Credit Fund, and interval fund, acquired the Griffin Capital Benefit Street Partners BDC, while the VII Peaks Co-Optivist Income BDC II converted to a new interval fund, known as the VII Peaks Co-Optivist Income Fund. FS Investments (formerly Franklin Square Capital Partners), the first sponsor to launch a nontraded BDC in 2009, has also switched to a focus on interval funds. The firm launched its FS Credit Income Fund and FS Energy Total Return Fund as closed-end interval funds.

Nontraded BDC NAVs have increased by an average of 4.98 percent year-to-date as of Sept. 30, 2017. NexPoint Capital increased 6.68 percent as the industry leader for those currently raising capital, while Sierra Income lagged at 2.56 percent. The S&P BDC Index, which tracks the leading BDCs that trade on major U.S. exchanges, was up 0.29 percent as of Sept. 30, 2017.

In terms of the capital stack, the nontraded BDCs have maintained a focus on the senior debt of the companies they invest in. For the past five years, the average allocation to senior debt has ranged between 75 percent and 85 percent.

The BDCs have increased their allocation to variable rate debt over the same time period, while decreasing the fixed-rate allocation. This makes sense given the potential for interest rate increases and inflation going forward.

CLOSED-END FUNDS

As nontraded REIT and BDC sales have dipped, the closed-end interval fund segment of the nontraded market has seen the greatest growth trajectory of the industry. According to Interval Fund Tracker, 43 total active interval funds are in the marketplace right now, with total net assets exceeding $23.8 billion. This represents a 56 percent increase over the past 12 months. Interval Fund Tracker also reported 23 interval funds currently are pending registration with the SEC, with credit strategies among the top strategies for new entrants. As existing BDCs continue to convert to this structure, and the flexibility and transparency associated with it, one could expect to see continued growth here.

1031 EXCHANGE PROGRAMS

Syndicated 1031 exchange programs, including Delaware Statutory Trusts (DSTs) and Tenant-in-Commons (TICs), all but disappeared in 2008 and 2009 as commercial property values plummeted. Numerous defaults and litigation against prerecession TIC programs hampered the industry through the recession. As commercial property values have appreciated post-recession, however, investment in these types of programs has once again picked up, with more than $8.0 billion in offering amount over the past five years. The number of programs offered in 2017 was more than double the number of programs offered in 2012, with a nearly quadruple offering amount. The majority of postrecession syndicated 1031s have been DST programs because of the less-complicated structure, and many of the prerecession 1031 exchange companies no longer exist. The leaders in the industry over the past five years, however, are two companies that were active before the recession — Inland Private Capital Corp., with about $2.5 billion or 30 percent of the total offering amount, and Passco Cos., with about $955 million, or 12 percent of the total offering amount. Both companies have focused more on net-lease properties or property portfolios in the DST structure.

LLCs/LPs

Investment in private programs, including limited liability companies and limited partnerships, primarily in the real estate sector, peaked in 2013 and has declined since then. This may be partially due to increased pricing in the sector or could be reflective of the shift toward more liquid alternative options, such as closed-end funds and alternative strategy mutual funds. One area that has seen an increase in activity is the preferred segment. The number of offerings and offering amount, while still lower than other nontraded segments, has increased significantly in the past five years, with 2017 seeing a record-setting $2.1 billion in seven programs offered.

The nontraded alternative investment market has certainly experienced its share of volatility over the past five years. Sponsorship of new programs has shifted alongside regulatory concerns and appreciating markets. Nontraded REITs and BDCs saw capital-raise declines, while closed-end interval funds and 1031 exchanges gained momentum. The entrance of institutional money managers into the nontraded space, as well as greater transparency into pricing and valuations, may be a signal of better times to come. This would be ideal, as the industry allows access to alternatives to a broader clientele than traditional alternative investments.

Laura Sexton is senior director of program management at AI Insight.