Private equity-led buyouts of real estate investment trusts show no sign of slowing down at midyear. Eight large privatizations worth $43.3 billion were announced through the first five months of 2007.

At this breakneck pace, deal volume should easily surpass last year's record activity that resulted in 11 REIT privatizations worth a combined $58 billion, reports Charlottesville, Va.-based SNL Financial (see chart).

It seems that nearly every REIT is now viewed as a viable takeout target. That's particularly true after apartment REIT Archstone-Smith was acquired by a joint venture that included Tishman Speyer and Lehman Brothers for $22.2 billion on Memorial Day. The deal is expected to close in the third quarter.

Sources also believe that an ongoing sell-off in REIT shares could spur added buyout activity through this summer. As REIT share prices decline, these companies become ripe for takeovers.

Shares of equity REITs posted a robust total return of 35% in 2006, according to the National Association of Real Estate Investment Trusts. But total returns have cooled considerably in 2007, rising just 3.5% through May 31.

Even worse, total returns took a major tumble in June as nervous investors trimmed their exposure to real estate. Total returns for equity REITs year-to-date as of June 21 registered a negative 5.06%.

“When the perceived valuations in the private market vastly exceed the valuations in the public market, it's a great way for buyers to acquire a portfolio in one fell swoop,” says Keven Lindemann, director of real estate at SNL Financial.

Lindemann believes that private equity firms will continue to hold an advantage as buyers of real estate. Unlike REITs and other public companies, private equity firms can juice their returns through massive dollops of leverage — up to 90% of the total deal value. REITs, on the other hand, typically are more conservative and limit their leverage to 60% of the total deal value.

“It's a great way to boost returns, and it allows [private equity investors] to outbid most of their competitors on the public side,” according to Lindemann.

One fly in the ointment: The 10-year Treasury yield, the benchmark for permanent, fixed-rate financing in commercial real estate, has breached 5% and even showed some signs of volatility over the past month. On June 13, for example, the 10-year Treasury yield swung wildly from 4.96% to 5.33%.

As of June 22, the long-term yield registered 5.13%. The rising long-term rate, coupled with tighter underwriting standards, will ultimately drive up financing costs and could dampen buyout activity.

But Judith Fryer, co-chairman of the REIT practice at law firm Greenberg Traurig, observes a “backlog” of investment capital in the marketplace looking for a home. “There is still just so much pent-up capital out there trying to enter the real estate market,” says Fryer, who has handled nearly a dozen private equity-led REIT privatizations in recent years. It's Fryer's belief that future REIT buyouts will occur, even if financing costs rise.

Jonathan Habermann, a REIT analyst with Goldman Sachs, writes in a research note in mid-June that “the sharp decline in REIT shares has created a unique buying opportunity as many high-quality REITs now trade well below their liquidation values.”

In other words, the arbitrage opportunities are still there for the taking. Lindemann expects leveraged buyout deals to force more REITs off the public stage by Labor Day.

In short, Lindemann does not expect private buyers to lower their REIT valuations to become more in line with the public market, at least not in the short run. If that gap between how the public and private markets value REITs remains as wide as is currently the case, private buyers will undoubtedly continue to exploit this mispricing.

“We're now down to 133 listed REITs from 200 just a decade ago,” says Lindemann. “Eventually the pool of available companies may shrink to the point where deals get harder to find. But we have a ways to go before that happens.”