Liquidity Penalty Box - When Small REITs Stay Stuck

I've sat on the boards of two industrial REITs, each with more than $3 billion in assets, and each ultimately acquired through a tender offer process. What struck me both times was that even at that scale, liquidity remained a real constraint. This, along with other factors, impacted their valuations and their ability to grow, which further impacted their liquidity.

Part of the liquidity issue was explained by the heavy concentration of long-term hold investors in Mexico. Here's a common scenario in the region: let's assume a REIT with 50% leverage and $2 billion in assets. That translates to roughly $1 billion in equity. If long-term investors ( pensions, in this case) hold a significant portion of that equity, the actively traded public float ends up being a relatively small number to begin with. And lower liquidity keeps global investors out of the stock.

That's what makes me think about the companies sitting well below $1 billion in total assets. If $3 billion isn't enough to guarantee a liquid, well-functioning stock, it's worth asking what the picture looks like for REITs a fraction of that size. Interestingly, there are a handful of REITs I've come across in the Latin American market that fit that profile and face a huge uphill battle.

If an emerging REIT is sub-$1 billion, I'm not saying it has lost hope. There are case studies across the globe where newer REITs achieved scale over the last cycle, some through acquisition, some through M&A, some through development, most through a mix of all three. Those companies often positioned themselves with a unique strategy, a differentiated management team, or best-in-class investor practices to garner more investor attention. But not all small companies have had success scaling, and some have remained in the liquidity penalty box.

These companies haven't found real differentiation from their peers. Their strategies and assets look like a smaller version of something a larger competitor already does. They exist as public companies, but from an independent lens, their reason for existing as a going concern comes into question. An ideal board decision would be to assess strategic options for the company, especially if it's been in the penalty box for some time.

Unfortunately, choosing a path to "explore strategic options, including a sale" is possible in theory but much harder in practice. History has shown that governance structures such as control provisions, board composition, or management arrangements make it difficult to start a strategic review, even where it might be in shareholders' interest.

In a well-functioning market, this kind of situation tends to resolve itself. Both of the boards I served on eventually went through scale limitations and a persistent discount that made the companies natural acquisition candidates, and a tender offer followed.

The market corrected the problem for investors.

But that correction only works if the company is actually available for it. When control provisions or board composition make a sale hard to even put on the table, the market's usual fix doesn't reach the company, and the discount just sits there, year after year.

After five to seven years, management has had sufficient time to execute and prove out its business plan. If a platform is still meaningfully sub-scale, still without real differentiation, and still without a credible path forward after that time period, it's probably not a temporary rough patch. And investors will share their opinion of the stock via their valuations.

I'm not suggesting every small REIT needs to sell. But I do think a board of a REIT sitting in the penalty box for a long time owes it to shareholders to formally revisit its strategic options rather than let the question go unasked simply because no one on the board is willing to raise it.