Megatypically is one of those overly dramatic phrases that the ego-driven, bigger-is-better commercial real estate industry loves to bandy about when it comes time for the annual ritual of retrospection. But when you consider that the largest deals in the history of U.S. commercial real estate were transacted in 2006, there can be no denying that at least in this instance the market lived up to the hype.
Some $102.8 billion in announced mergers and privatizations involving REITs occurred in 2006 — nearly double the amount of activity for all of 2004 and 2005 combined, reports SNL Financial of Charlottesville, Va. (see chart, p. 40) Among the major players, New York-based The Blackstone Group led the pack, accounting for an incredible $53 billion in REIT transaction volume in 2006. The privatization phenomenon was driven by institutions and equity funds, which needed a quick and tidy home in stable assets.
That has made portfolio plays much more efficient than nabbing one-off assets, and drawn a bulls-eye on the back of most publicly traded REITs. After all, they have been accumulating assets for years, and many are still feeling a tad undervalued by the prevailing stock markets.
Does the privatization trend mean publicly traded REITs have lost their appeal as a business model? “It's a different risk profile and a different growth profile, and public companies will be relevant,” says Ross Smotrich, senior managing director and REIT analyst at New York investment banking giant Bear Stearns.
In the short term, however, REIT stocks may be getting too pricey, says Sam Chandan, chief economist with real estate research firm Reis Inc. in New York. “Are their valuations so high now that they will discourage activity and result in a change in how investors are thinking about the upside opportunity? That creates some downside risks about valuations in 2007,” emphasizes Chandan.
The years ahead will prove challenging to Blackstone and others. What will these companies do with their new bounties, otherwise known as an exit strategy? According to John Kriz, managing director of real estate finance at Moody's Investors Service in New York, the options are to liquidate or go public, again.
“The ultimate takeout for these privatizations is for them to go back public,” says Kriz. “How else do you sell that much? Sell it to another private equity firm? The only way to execute quickly is through an IPO.”
In the interim, Kriz warns that buyers could find the economics of their deals increasingly difficult to pencil out. “Looking at the cash-on-cash yields in the marketplace, I would express caution. You have to look at how much equity they're putting in at risk. Then throw in fees for deploying the money, fees for working the money and the rest. If they don't put the money to work, guess what happens? They lose their jobs.”
What follows are details of five deals, either completed or pending, which are changing the ownership landscape in commercial real estate.
- Blackstone takes EOP private
If there was a bellwether for the state of the industry in 2006, this was it. Call it “Blackstone at the Gate” or “The November Surprise.” Either way, on Monday morning, Nov. 20, 2006, Blackstone Group announced it was buying the nation's largest office landlord, Chicago-based Equity Office Properties Trust (EOP), capping off a year of intense privatization deals.
To be sure, the $36 billion transaction — including $16 billion of debt — involves a mammoth portfolio of 580 buildings with 108.6 million sq. ft. in 16 markets. But more importantly, it became the largest leveraged buyout and privatization in U.S. business history.
According to EOP's proxy filing in December, merger talks with undisclosed firms were initiated as early as 2005. For much of 2006, rumors swirled that EOP was a merger candidate, especially after announcing in July its intentions to vacate Atlanta altogether, and sell off assets in major markets such as Chicago, Denver and Northern. Other signals were mixed, with EOP making a few high-profile purchases, including 1540 Avenue of the Americas in New York City for $525.1 million in July.
Richard Kincaid, CEO of the behemoth REIT, insists he was not positioning for a merger. “We received an unsolicited, but compelling offer, which was a 20.5% premium over EOP's three-month average closing price,” Kincaid says. “As a public company, we had a fiduciary responsibility to our shareholders to respond to a compelling offer, and that's what we did. Prior to this offer, we were running EOP as a long-term public company.”
One point that's perfectly clear, according to the merger filing, is that EOP owes Blackstone a hefty $200 million termination fee, if the deal falls through. However, all signs point to the merger successfully closing in the first quarter of 2007.
There's a larger question yet to be answered, says Kriz of Moody's. “How are you going to take these assets and create value with them?” Raising occupancies is one option, with EOP's portfolio standing at 91.1% leased as of Sept. 30, 2006 compared with 89.3% at the close of the same period in 2005. Raising rents could also bring higher yields, since many forecasters agree there is significant upside in both office rents and space demand for at least the year ahead.
Asked if EOP's operations would be substantially different under Blackstone ownership, Kincaid responded, “We don't know.”
- Blackstone gobbles up MeriStar
You've got to hand it to Blackstone. The giant private equity outfit likes to spread around its money, and hotels have been a favorite on its investment menu for the past two years.
In early 2006, Blackstone bought MeriStar Hospitality Corp. based in Bethesda, Md. in a $2.6 billion deal. At the time of the acquisition, MeriStar owned 57 upscale full-service hotels in major markets and resort locations with 16,507 rooms in 19 states and the District of Columbia. The portfolio included 10 properties that were already under contract for sale to Blackstone for $367 million.
That buyout amounts to $157,509 per room, and Blackstone assumed $1.6 billion in MeriStar debt. Through the purchase, Blackstone owns some landmark properties, including the Ritz-Carlton Pentagon City and the Hilton Washington Embassy Row.
But Blackstone is anything but a newcomer to the hotel business. In 2005, it bought out La Quinta for $3.4 billion, as well as Wyndham International Inc. for $1.44 billion. That followed acquisitions of Extended Stay America, Prime Hospitality and Boca Resorts over a seven-month period totaling $3.3 billion. Of those assets, Blackstone already has sold the AmeriSuites chain and the franchising rights for the Wyndham chain.
Former MeriStar chairman and CEO Paul Whetsell left the company last summer to start Bethesda-based CapStar Hotel Co., which acquires and develops hotel properties in major U.S. urban markets.
A glimpse at the hospitality industry's real estate fundamentals speaks to Blackstone's obvious interest in the sector. Industry profits increased 13.1% for the first half of 2006 over the same period a year ago, according to a recent report from Atlanta-based PKF Hospitality Research.
“The MeriStar transaction is emblematic of exactly where the industry is today,” says Mark Woodworth, president of PKF Hospitality Research. “We're going to look back at 2006 and say this really was the peak year of performance for most industry measures.”
As for Blackstone's short-term plans, Woodworth sees dispositions on the horizon. “I suspect they will see if there are some assets that are in markets and locations that have shifted to a degree where they can be repositioned through physical change, change in brand or change in the operator.”
Longer term, Blackstone's exit might be through an IPO in the next three to five years. But for now, Woodworth says, “It's a great time to be a buyer of hotel real estate.”
- DDR buys ‘dream portfolio’
Bart Wolstein, the late founder of shopping center giant Developers Diversified Realty Corp. (DDR), forged a 50-year commercial real estate legacy in metro Cleveland. Now his son Scott Wolstein, DDR's CEO since 1992, is making his own mark, but on a more global scale.
In a single stroke last October, Cleveland-based DDR purchased Oak Brook, Ill.-based Inland Retail Real Estate Trust Inc. in a $6.3 billion deal, including $2.3 billion of debt. The move was, says Wolstein, a “transformative event for our company [in which] we will emerge with a dream portfolio.” Inland Retail's portfolio includes 307 properties, mostly community and neighborhood shopping centers in the Southeast, with an average occupancy of 95%.
To help fund the transaction, DDR formed a joint venture fund with institutional investor TIAA-CREF to buy a 50% stake in 67 of Inland Retail's community center assets for about $3 billion. The fund has capacity to purchase up to $1 billion in additional property. Wolstein pegs the cap rate of the joint venture properties at 6.2%, and 6.5% on the assets to be wholly owned by DDR, which post-merger will own 800 shopping centers totaling 162 million sq. ft.
In short, the Inland Retail deal had everything Wolstein was looking for: a relatively young portfolio with assets on average 7 years old; healthy demographics in key Southeast cities like Atlanta, Charlotte, Miami and Orlando; and dominant tenants in key retail categories. Plus, DDR will have more than 5 million sq. ft. of space in California, Texas, New York, New Jersey and Ohio.
Now, Wolstein is relying on DDR's ability to proactively manage the assets of the joint venture to realize both operating efficiencies and potentially higher rents. With 34% of the Inland Retail portfolio's space coming up for renewal over the next five years, he hopes to reward investors with significantly higher returns.
Since DDR's acquisition of Atlanta-based JDN Realty in March 2003, it has taken on more than $5 billion in acquisitions, not including the Inland Retail deal, which is set to close in the first quarter of 2007. During that period, investors have seen DDR's stock price more than double, from $31.69 to the mid-$60s as of mid-December.
- Tishman Speyer takes Manhattan
In worldwide art circles, Jerry Speyer is a well-known collector and philanthropist. But he also collects and trades some top-shelf office properties in various corners of the world — think Rockefeller Center and the Chrysler Building.
In late 2006, the president and CEO of New York-based Tishman Speyer Properties, along with his son Rob, decided to take on the apartment business in a big way.
In partnership with New York's BlackRock Realty, the partnership closed on the $5.4 billion purchase of Manhattan's Stuyvesant Town and Peter Cooper Village from seller MetLife, making it the largest single-property transaction in history. The deal includes 80 acres along the East River, with some 25,000 residents in 11,232 apartments and 110 buildings.
Equally remarkable is the speedy closing schedule — just 30 days — despite tenant protestations and attempts to block the deal. “We had a very tight time frame; we stuck to it, Met stuck to it and we made the buyer stick to it,” says Bill Shanahan, who as vice chairman and partner at CB Richard Ellis co-brokered the deal with partner Darcy Stacom for MetLife. “Honestly, for these buyers to get this done in the timeframe they did, it was like drinking from a fire hose.”
The property includes two complexes that have been home to firefighters, nurses, and civil servants for decades, after MetLife built the complexes as affordable housing in the late-1940s in exchange for tax breaks and other subsidies. “There's nothing else like this,” says Shanahan. “It's bigger than a lot of small towns in the United States. Each of the complexes is its own census tract. In some respects, you were buying two towns.”
The Speyers likely will spend the next six to 12 months exploring a variety of revenue-generating ideas. “We spent a fair amount of time coming up with creative strategies for the complex, things that would maximize unused areas of the complex. We think that really helped drive the pricing — showing ways to produce additional income in the property,” says Shanahan.
Since 73% of the tenant leases are rent stabilized, how quickly the new owners decide to mark many of those units up to higher market rates will be key.
- ProLogis creates $4 billion fund
Talk about another way to go private. ProLogis, the nation's largest industrial REIT, formed a $4 billion North America industrial fund in early 2006, ostensibly to help fund continued growth, but also to tap into private equity's continuing demand for property.
ProLogis, based in Aurora, Colo., first explored the fund creation strategy in 1999, and this marks its 13th venture to date. The new North America fund, which is the first to feature an open-ended, infinite-life structure, includes $1.5 billion of third-party equity, ProLogis' 20% equity interest and 55% to 60% leverage.
The fund's initial portfolio includes 12.2 million sq. ft. in 77 buildings in 23 U.S. markets, which ProLogis purchased in January 2006 when it acquired the remaining 80% interest in each of ProLogis North American Properties Funds II, III and IV.
Along with other major property sectors, industrial has caught the eye of the private-equity players, a fact that helped drive the fund launch, says ProLogis CFO Dessa Bokides.
“What we have seen since 1999 is that institutional capital is interested in a lot of different pieces of real estate, but the industrial class is difficult to get hold of,” says Bokides. She believes the fund's $4 billion capacity will support the company's development and acquisition activity in North America over the next two to three years.
An affiliate of GIC Real Estate Pte Ltd (GIC RE), the real estate investment arm of the Government of Singapore Investment Corp., is the largest investor in the fund.
In 2005, ProLogis did its part to consolidate the U.S. industrial market by acquiring rival San Francisco-based Catellus Development Corp. for $3.6 billion. And in 2004, ProLogis bought Keystone Property Trust, a West Conshohocken, Penn.-based industrial REIT, for $1.7 billion.
Bokides says more acquisitions are on the way, with ProLogis targeting smaller privately owned portfolios. The funds add another capital driver for growth. “For REITs like us, we need capital. And with the structure we've developed, we have access to debt and equity in both the public and private markets.”
Ben Johnson is a Dallas-based writer.
|Buyer(s)||Target||Property Focus||Deal Value||Status|
|Blackstone Group||Equity Office Properties||Office||$36 billion||Pending|
|Brookfield Properties, Blackstone Group||Trizec Properties and Trizec Canada||Office||$8.9 billion||Closed 10/5/06|
|Developers Diversified Realty Corp.||Inland Retail REIT||Shopping Centers||$6.3 billion||Pending|
|SL Green Realty Corp.||Reckson Associates Realty Corp.||Office||$6 billion||Pending|
|Crown Castle International Corp.||Global Signal Inc.||Specialty||$5.8 billion||Pending|
|* as of 12/15/06, totals include debt and preferred securities assumed in transactions |
Source: SNL Financial