IBD | Stock Market Sets Stage for REIT Acquisition Trend

Investor's Business Daily: Stock Market Sets Stage For REIT Acquisition Trend

6/5/15, 9:40 AM

Stock Market Sets Stage For REIT Acquisition Trend June 4, 2015 JOE GOSE INVESTOR'S BUSINESS DAILY Posted with permission from Investor's Business Daily

Investors in real estate investment trusts haven't had much to complain about over the past six years. REITs overall have generated total annual returns around 20% or more in four of them, counting share price gains and dividends, and they've stayed out of negative territory in the other two years.

Now, just as the robust performance is waning — property REITs rank a low No. 175 in stock market performance among 197 industry groups that IBD tracks — potential buyers are in the best position in years to snap up the trusts and take them private.

In a report last month, Fitch Ratings declared that the REIT "go-private" countdown had commenced, thanks to abundant capital; easing underwriting standards; commercial real estate's long-running fundamental rally; and the fact that private buyers were beginning to value real estate more highly than the public market.

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Growing investment activity in REITs among activist funds, such as Land and Buildings, also could play a role in a takeover trend, a prediction made early this year in a report by Green Street Advisors, a REIT and real estate research firm.

Going-Private Predictions If the prognostications are correct, the go-private surge could be the biggest since 2006 and 2007 when 30 REITs crossed the Rubicon in deals valued at $123 billion, Fitch said.

"All the conditions are there such that, in our opinion, transactions should occur and will occur," said Britton Costa, a Fitch analyst and an author of the report. "When you look at where we are today, it's very reminiscent to where we were just before the last wave."

What's more, he says, unlike a decade ago, sovereign wealth funds from Asia, Europe and the Middle East are in the market and over the last several months have increased their appetite for U.S. commercial real estate.

With billions of dollars to spend, sovereign wealth funds and other private capital pools are focused on the size of portfolios that REITs typically own versus trying to buy properties piecemeal on "Main Street," adds Jim Sullivan, a managing director with Green Street.

The potential shopping spree also happens to parallel interest rate hike concerns, which are likely contributing to REIT share prices trading at a discount to the value of their underlying properties, or net asset value, he says.

"If you believe that rates are going to go up, that's a scenario that people worry about in capital intensive industries like real estate," Sullivan said.

"But isn't it interesting," he added, "that there's an ocean of capital increasingly looking to Wall Street to buy real estate because REITs are trading at a discount to their net asset http://license.icopyright.net/user/viewFreeUse.act?fuid=MTk1NzQ3NzY%3D

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Investor's Business Daily: Stock Market Sets Stage For REIT Acquisition Trend

6/5/15, 9:40 AM

because REITs are trading at a discount to their net asset value? And it's perhaps cheaper than real estate on Main Street."

The value disparity between the private and public marketplaces hasn't escaped REIT CEOs, who in some cases addressed the issue in first quarter earnings calls.

Private equity giant Blackstone Group is among firms recently inking deals to buy real estate investment trusts. View Enlarged Image

Commenting on recent transactions in the industrial sector, for example, Denver-based DCT Industrial Trust (NYSE:DCT) CEO Philip Hawkins last month noted that private buyers were evaluating properties "more richly than the public markets," possibly due to a more rigorous analysis and favorable capital environment.

"I'm not sure that's why the public markets have underappreciated industrial this year," he told analysts, "but the underperformance of public industrial REIT stocks is pretty striking in comparison to what's happening in the private capital markets right now."

The private-public value gap isn't just showing up in the industrial sector, however. To some degree, apartment, office, retail and hotel REITs also are trading at a discount to NAV, Sullivan says.

"It's not across the board," he said, "but it's more sectors than not."

Conversely, more specialized REITs that own net-lease assets, health care properties and self-storage facilities are generally trading at premiums to NAV, Sullivan adds.

Trend Forerunners?

Fitch points to few recent deals as harbingers.

In early April, Blackstone Group's (NYSE:BX) Blackstone Property Partners real estate fund agreed to buy San Diego-based shopping center REIT Excel Trust (NYSE:EXL) for a 15% premium to the company's stock price, in a deal valued at roughly $2 billion.

Almost two weeks later, a private real estate fund affiliated with Brookfield Asset Management (NYSE:BAM) said it would pay an 18% premium for the shares of Cleveland-based apartment REIT Associated Estates Realty (NYSE:AEC) in a $2.5 billion deal. That sale followed Land and Building's demands that the REIT find a buyer.

In February, privately held real estate landlord Edens Investment Trust paid a 40% premium for the shares of Houston-based AmREIT, an owner of urban retail and mixed-use properties, in a $763 million transaction. The offer was nearly double that of an unsolicited bid by Jacksonville, Fla.-based REIT Regency Centers (NYSE:REG).

Returns Slowing Down REITs generated an average total return — stock appreciation plus dividends — of 30% in 2014, according to the FTSE NAREIT U.S. Equity REIT Index.

REITs also reported an average total return of nearly 7% in January, but through the end of May they had given up those gains and were flat for the year, according to the index.

Despite the unimpressive stock performance of REITs so far this year, share prices are still near all-time highs, Costa points out. Plus, the current multiple of share price-to-"funds from operations" — the primary measure of REIT operating performance — is 240 basis points higher than the 11-year average, he says.

Those considerations and the likelihood that landlords already have witnessed the biggest chunk of occupancy and rent growth for the next few years could make REITs more receptive to offers.

"A management team could decide that they're not leaving too much on the table," Costa said. "So they might be a little more prone to have a conversation if someone called them."

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