The changing face of real asset investments - Part 2

Wednesday, November 21, 2018 | By Delia Kirschenbaum and Drew Ruffini

The changing face of real asset investments - Part 2

In our recent blog post, The changing face of real asset investments, we addressed key trends impacting the industry. We explored how the growing population influences agricultural land demands and how real assets generally are not impacted by natural disasters.

This blog explores other real assets – specifically, cell towers and music royalties – and the trends that impact investing in them and how SS&C GlobeOp can help.

A growing population staying connected 24 x 7

It’s likely that you’re reading this blog on a device using mobile data. Mobile technology keeps us connected to our jobs, entertains us and helps us manage our lives with applications we can’t imagine living without. The number of smartphone users is forecasted to increase by ~2.5 billion in 2019, with smartphone penetration rates increasing, as well. Just over 36 percent of the world’s population was projected to use a smartphone by 2018, up from about 10 percent in 2011.[1] This continuous rapid growth of mobile device usage has generated an enormous increase in wireless data consumption, placing increasing demands on the carriers to enhance network capacity, quality and coverage.[2]

Cell towers: Meeting demand for broad and fast coverage

We have all seen the maps used by carriers to illustrate the global reach of their networks. These have evolved considerably as the demand for “staying on the grid” has accelerated. Coverage has improved so much that gone are the days when we can claim our week at a cabin in the woods prevented us from seeing an email from our boss or the days when we couldn’t instantly post pictures from our travels. To support the demand for broader, faster coverage, carriers need to continue installing more cell towers with more transmitting power.

In densely populated areas, there are fewer areas where such towers can be installed, and the demand presents opportunities for tower owners and their investors. Cell towers not only support mobile devices, with carriers like AT&T and Verizon as tenants, but also support other technologies like paging, broadcast television and radio – providing multiple tenants per tower and various streams of lease income. The owner of the tower typically owns the tower structure, owns or leases the land the tower sits on and owns power generators that provide backup power to tenants.

Mobile technology changes quickly. New devices are continually being introduced, and the advent of 5G technology has further increased demand for towers to support it. And just because a tower supports one type of device, that doesn’t mean it will support other devices. This results in needing new towers to support existing and emerging technologies until the emerging technology becomes the norm and the current technology becomes that of the past.  In areas that restrict building new towers, owners seek buildings that can house Distributed Antenna Systems (DAS). DAS are networks of low-range antenna sites that can be deployed in a wide variety of properties such as airports, shopping malls and sporting arenas. For example, 300 DAS installations were used at the London 2012 Olympics to support 359,000 mobile users at one time in a part of London that previously had little coverage.[3]

Cell towers as an investment

The cell tower business model is one of the most attractive, boasting consistent cash flow growth with low-maintenance capital expenditures[4]. Towers are generally held as a REIT (Real Estate Investment Trust). The implementation of 5G[5] should be a massive home run for cell tower REITs and is expected to buoy revenue growth for the better part of the next decade.[6]  Although the fund structures holding REITs are attractive to private equity investors given their expected growth, the business model has come under fire recently most notably, due to the potential merger between two of the largest tenants, Sprint and T-Mobile. The cell tower REITs have produced a total return of -7.2 percent from March 31, 2018 through May 24, 2018, which compares to the RMZ total return of +2.9 percent. According to Seeking Alpha, they believe fundamentals are intact due in part to an expected massive ‘5G’ spending cycle by the carriers that will re-accelerate organic cash flow growth from numbers that are already above the REIT average.

Private REITs hold, finance and operate real estate assets, including cell towers. They provide high investment performance and portfolio diversification and, regardless of its underlying holdings, must meet very specific criteria:

  1. Invest 75 percent of its total assets in real estate. For the cell phone industry, ownership can come in the form of cell towers (or leased rooftops, water towers, etc.) and the land associated with them. 
  2. Derive 75 percent of its income from rental of real property. With reference to the cell phone industry, rent comes in the form of payments from all major communication companies paying to make use of the leased assets listed above.
  3. Pay 90 percent of the income to shareholders each year. In the case of a REIT as part of a private equity structure, the REIT passes the income up to the master/feeder or parallel funds (where the private equity investors invest) that own the REIT. In addition, there are shareholders not directly invested in the private equity structure that receive income, as well. More on that below.
  4. Include 100 shareholders. This is a unique issue for private equity structures, as investors don’t typically invest directly in a REIT. As discussed above, it is typical that a master/feeder or parallel structure invest in the REIT, but that isn’t enough to satisfy this specific requirement. In order to get over the threshold, most private equity management companies elicit the help of outside consultants that specialize in the REIT industry. REIT Funding, LLC is one such consultant. They provide an avenue for the additional offerings, documentation and filing services that private REITs need to meet the IRS requirement.

Royalties: Music to investors’ ears

While on that vacation in the woods, you may take a leisurely stroll (after addressing your work emails!),  with a device strapped to your arm and wireless headphones in your ears, listening to your favorite music streamed through a digital music service. You wouldn’t be alone – nearly 500 million others subscribe to such services.[7] The increasing popularity of such services has sparked a renewed interest in private equity funds holding music royalties. The funds acquire the rights to catalogs of music and individual songs, which they own for a specified number of years. Every time one of those songs is played, purchased or used for any commercial purpose — anywhere in the world — the fund collects the royalties, and investors earn returns.[8] Royalties are also paid on copyrighted music played at live performances, recorded on a CD, played in an elevator or as part of the introduction to your favorite television show. For example, an opening song for a U.S. television show declining in popularity in the U.S., may have additional play time (and revenue) when the show is syndicated in other countries or streamed via a subscription service, gaining a new audience for another run of the show. All in all, a good investment that is not tied to stock market volatility.

SS&C’s expertise in administering income generating real asset funds lends itself well to administering those holding music royalties. Like all real asset funds, these funds have specific nuances that require specific accounting. We detail below a few specific fund operation highlights.

Music royalty fund operations

The funds within the private equity fund structure holding the royalties, individually or through investment fund or special purpose vehicles (SPV), provide a cash advance to the royalty holder based on a documented agreement between them. The royalty holder is generally an artist; however, it could be a third party if the asset is purchased in the secondary market. The fund records the advance as an investment purchase for which the rights of purchase were assigned, and in return the fund receives an assignment agreement.

The fund’s investment manager may appoint a manager (sometimes referred to as a publisher) or agent to oversee various music-related assets including, but not limited to, the collection of royalties. The publisher (or agent) may provide additional services to the fund and other guidance such as advising on music-related activity and assets available for acquisition, managing the assets and providing support to the artists. 

For as long as the fund owns the royalties, royalty proceeds (i.e., collections) are collected and accounted for on a periodic basis. Upon receiving the collections, the publisher/agent will distribute the proceeds, net of their fee, to the fund per the established agreement. Subsequently, the fund for their accounting records will apportion some of the royalty collections to recoup the cost of the investment at the discretion of the fund’s investment manager, with specific consideration given to the remaining life of the royalty agreement, the popularity of the musician and the income generating potential. The remaining amount collected makes its way through the fund structure with eventual distribution to the fund’s investors as income.

Choosing the right administrator

Whether a cell tower or music catalog, each real asset has its own nuances, and knowledge of the asset class and accounting expertise is a must. The fund structures holding these assets are complex, employing blocker entities and special-purpose vehicles to hold each cell tower project or music catalog. SS&C has the technology and staff to properly account and report on these structures across several assets classes. However, managers’ focus on one asset class over another is influenced by specific trends that impact the potential return. The SS&C GlobeOp Real Assets team understand the nuances that impact the proper accounting as much as the trends the influence their popularity.

To learn more about the SS&C GlobeOp solutions and services, please visit SS&C Real Asset Services.

Alternative Investments, Asset Management, Fund Administration, Real Estate & Property Management

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