Even if interest rates in the U.S. trend up and REIT stocks begin to flatten, deal making merger and acquisition activity in the REIT sector should remain on a robust course. That’s the consensus of an expert panel convened at the annual National Association of Real Estate Investment Trusts, Nov. 2-4.
With the $5.5 billion combination of ProLogis and Catellus Development Corp. in September leading the way, there were 116 mergers and acquisitions — including going-private transactions — involving REITs through Oct. 31 this year, with a total value of $24.44 billion, according to FactSet Mergerstat LLC in Los Angeles. Industry executives expect 2005 to surpass activity in 2004, when there were 124 deals valued at $23.03 billion.
“I think merger-and-acquisition activity in 2006 will match or surpass this year's volume of activity," said Louis W. Taylor, a managing director of New York-based Deutsche Bank Securities Inc., who was part of a panel addressing the subject. "There is $40 billion or more in capital lined up that wants to get into the U.S. real estate sector. That money will help fuel deal making."
Of course, some of that money has been employed recently to take some REITS private, particularly in the multifamily sector. Amli Residential Properties Trust was acquired by an affiliate of Morgan Stanley for $2.1 billion in late October and taken private, and earlier in that month ING Clarion took Gables Residential Trust private in a $2.8 billion transaction.
Panelists forecast more such deal making in coming months, particularly if public stock prices falter. Marc R. Halle, managing director of Prudential Investment Management in Parsippany, N.J., believes that REITs with market capitalizations of $3 billion or less are the best candidates for privatization. "Investors want to see risk diversified, and it's harder for the small companies to accomplish that," Halle said.
Indeed, there is a growing consensus that smaller REITs must get large to survive. "Amli and Gables didn't have great scale, and so it probably made sense for them to go private," said Richard J. Campo, chairman and chief executive of multifamily specialist Camden Property Trust, which acquired Summit Properties Inc. in February in a $1.7 billion merger.
Nicholas S. Schorsch, president and CEO of American Financial Realty Trust in Jenkintown, Pa., noted that his company has raised $1.8 billion in the public markets over the past three years to grow its portfolio to 37 million sq. ft. of various property types in 39 states. "Size was important to us," Schorsch said. "Our bankers wanted to see diversity on our balance sheet."
One impetus behind privatization, panelists agreed, was the public aversion to development and new construction in the REIT sector. "Development is a challenge for public REITs because it often forces them to sacrifice earnings in the short term," said Campo. Added Halle of Prudential: "REIT investors like recurring income. I don't think the public market understands development very well."
There are some 80 REITs with market caps under $2 billion, but experts do not expect a wholesale rush among the group to go private.
Indeed, there is little likelihood that the publicly traded REIT sector overall will shrink in coming months. In the past 12 months there have been 16 initial public offerings of REIT stock. The new issues will keep coming in 2006, the panel predicted. "Public companies are great cash-flow vehicles for investors. There is a definite place for public companies," said Campo of Camden.
"No matter what, the REIT sector should enjoy net growth in the next year," Taylor of Deutsche Bank said. "Smaller companies will go private in some cases. But larger companies will continue to grow to take up the slack."
Taylor expects that hostile takeover bids will become increasingly rare in the coming year. He also thinks that mega-deals of the ProLogis-Catellus variety will become scarce. "There aren't many mergers involving large companies on both sides of a transaction that would make sense at this point," Taylor said.
Most active REIT sector for M&A in 2006? Taylor says it will be the office category, followed by apartment REITs. Retail had been most active in 2004, but "the retail sector has run out of targets, and the industrial sector has nearly run out, too," Taylor said.