Privatization can unlock REITs’ full asset values when share prices fall short.
The pending $8.9 billion acquisition of Trizec Properties is the latest and largest of more than a dozen recent examples of investors snapping up REITs that are perceived to be undervalued by the public markets — and industry watchers say more privatizations are likely forthcoming.
Under terms of the deal, announced June 5, Trizec will be acquired by a joint venture of The Blackstone Group, a private investment and advisory firm, and Brookfield Properties Corp. (NYSE, TSX: BPO), a public real estate company that ranked No. 11 on National Real Estate Investor’s 2005 ranking of the nation’s largest office owners. On that same list, Trizec came in as the third-largest office owner.
The buyers agreed to pay $29.01 per share for Trizec Properties Inc. (NYSE: TRZ), plus an additional $1.96, or $30.97 per share, for all outstanding shares of Trizec Canada (TSX: TZC). That represents an 18% premium over the closing price of $24.60 for Trizec shares on June 2, the last close before the June 5 announcement. In all, Brookfield and Blackstone will pay approximately $4.8 billion in cash and assume another $4.1 billion in Trizec debt.
The deal technically is not a privatization, since Trizec will merge into Brookfield, a public company. Nevertheless, the transaction shows that investors like Brookfield and Blackstone are willing to pay a premium on the share prices some REITs fetch on the public markets. And with REIT shares weakening — the Dow Jones REIT Composite Index is off 9% since late March—more companies are finding that their real estate is worth more than their total market capitalization. In other words, you can still pay a premium for the stock and get a reasonable price for the assets.
“We think that REITs are trading, on average, in the neighborhood of a 10% discount to net asset value,” says Barry Vinocur, editor of Realty Stock Review. Net asset value is the total value of a REIT’s real estate divided by the number of shares. “Some are trading at a larger discount, and some are trading at par or a premium to net asset values.”
That’s why many Wall Street types figure more REIT acquisitions will follow. “This represents the 14th major REIT privatization/merger since January 2005 and the largest transaction,” Lehman Brothers analyst David Harris wrote in a June 6 opinion on the Trizec acquisition. “We believe the news confirms that capital remains available for property investment, [and] we would not be surprised to see more transactions, particularly in the office sector.”
Even after adding a premium to Trizec’s share prices, the buyers are getting a deal in line with current market returns for office properties. Lehman Brothers estimates the cap rate on the deal to be 6.3%, or $210 per sq. ft. for Trizec’s portfolio. That is slightly lower than the 6.5% cap Lehman estimated for Blackstone’s deal to privatize CarrAmerica Realty Corp. in March.
The implied capitalization rate is estimated at 6% by Merrill Lynch analyst Steve Sakwa, based on his assessment of Trizec’s net asset value per share of $25.74 in the first quarter. “This [capitalization] rate is in line with recent office transactions over the past year,” Sakwa reported on June 5.
The deal is intended to give Trizec stockholders the full value created over the past three years, in which those shareholders received “an extraordinary return of 185%,” boasted Peter Munk, chairman of both Trizec Properties and Trizec Canada, in a statement announcing the deal.
“Even though Trizec has made great strides and has delivered one of the best total returns to stockholders for office REITs during the past three years, the company continues to be undervalued in the public markets,” Tim Callahan, president and CEO of Trizec Properties said in a prepared statement. “In recognizing the underlying value of the company’s office portfolio, and especially its operating platform, the transaction announced today accomplishes Trizec’s ultimate objective as a public company, which is to maximize stockholder value.”
The boards of directors at Trizec Properties and Trizec Canada voted separately to approve the merger and arrangement agreement and recommended approval by stockholders.
Just what is the Brookfield/Blackstone JV getting for its money? Trizec owns and manages approximately 40 million sq. ft. of office space in 61 properties, concentrated in seven major U.S. markets. That’s nearly equal to Brookfield’s existing portfolio of 48 million sq. ft. in the U.S. and Canada.
However, under terms of the deal, Trizec is expected to sell approximately 12.1 million sq. ft. of its properties prior to being acquired, according to Melissa Coley, vice president of investor relations at Brookfield. Those properties, to be purchased by outside parties and possibly by Blackstone, are in Atlanta, Dallas, West Lost Angeles, San Diego, Chicago, Charlotte and Minneapolis.
After the acquisition, Brookfield will manage and operate 18.5 million sq. ft. of Trizec’s properties in New York, Washington, D.C., downtown Los Angeles and Houston. Those properties fit in with Brookfield’s existing operations or complement its emphasis on certain economic sectors, Coley says. “Our strategy is to be in strong markets where the drivers are financial services, energy and government,” she says.
Houston will be a new addition to Brookfield’s energy market practice, which currently includes Denver and Calgary, Canada; while Trizec’s properties in downtown Los Angeles will mesh with Brookfield’s financial services markets, which include Boston, New York and Toronto. Brookfield’s government-oriented markets include Ottowa and Washington, D.C.
Blackstone intends to manage and operate 5.4 million sq. ft. of Trizec’s properties in West Los Angeles, San Diego and New York. “It’s basically that some markets make sense for us, and some make sense for them,” Coley says.