One of the big stories of 2004 continues to be the brisk pace of merger activity among real estate investment trusts (REITs), particularly in the mall sector. Through Oct. 20, there were 18 merger announcements totaling $34.1 billion, up from 15 deals worth $6.5 billion for all of 2003, according to SNL Financial, a research firm based in Charlottesville, Va.

In August, mall giant General Growth Properties Inc. announced that it would purchase The Rouse Co. in a $12.6 billion blockbuster deal. In other notable transactions, Simon Property Group in June said it would pay $4.8 billion to take over the outlet centers of Chelsea Property Group, while Brandywine Realty announced in August that it would pay $600 million for Rubenstein Co., an office owner.

Apartment companies also have been growing through strategic acquisitions. Camden Property Trust announced in October its acquisition of Summit Properties. The two apartment REITs fit together like pieces in a jigsaw puzzle, say industry experts. Summit, based in Charlotte, N.C., owns apartments in Washington, D.C. and southeast Florida, while Houston-based Camden has holdings in Texas, Nevada, Orlando and Tampa. By spending $1.9 billion on the purchase, Camden will gain economies of scale and expand into new territory.

“The amount of REIT consolidation in 2004 has been surprisingly strong versus my expectations,” says Ralph Block, a consultant to institutional and private investors and CEO of Essential REIT Publishing Co., which provides analysis on REIT investing. “The common denominator for General Growth, Simon and Camden is that they want to make strategic acquisitions as opposed to picking up assets on the cheap. The strategic business reason is that these guys want to be around for the next 10 or 20 years.”

The Importance of Market Share

For Brandywine, the acquisition of Rubenstein offers clear economies of scale. The two companies had long competed against each other, owning Class-A offices in the Philadelphia area. The deal included 1.7 million sq. ft. in Radnor, Pa., that was less than 90% leased. Brandywine CEO Gerard Sweeney says the vacancies could present a growth opportunity at a time when the economy is expanding.

In another move that joined rivals, hotel operator CNL Hospitality Properties in February paid $2.1 billion for KSL Recreation, the owner of six luxury resorts, including the 738-room Arizona Biltmore Resort & Spa in Phoenix and the 780-room Grand Wailea Resort & Spa in Maui, Hawaii. The transaction will create the second-largest hotel REIT with 136 properties and more than $6 billion in assets.

John A. Griswold, president of CNL Hospitality, believes that merger will strengthen his company's resort business by adding units with loyal followings and unusual locations. “If you want to build a competitor to Grand Wailea, you have to go a couple miles down the road and make a significant investment,” he says.

Griswold says the resorts are particularly appealing because they provide diverse sources of income. Some have golf clubs that collect steady membership dues even when resort travel is down. All the KSL resorts serve business conventions as well as individual vacationers. During some holiday periods when the convention business is slow, vacation volume is peaking.

Even before the acquisition, CNL owned some upscale resorts, but most of its holdings were conventional hotels, operating in such chains as Hilton and Marriott. The acquisition provides more strength in resorts and helps the company expand operations in such fast-growing states such as Florida and Arizona.

Near-Term Outlook

Despite the increased velocity in M&A activity in 2004, analysts and consultants anticipate that consolidation will continue at a moderate pace in the near term. Why? For starters, REIT deals tend to be expensive, says Block, the author of Investing in REITs. When REIT stocks are in favor with investors, most REITs will see their shares appreciate.

“Any company that wants to use its shares as currency is going to find that when its currency is expensive, the shares of the company it seeks to acquire also are expensive,” Block says. Acquirers also don't like to use a lot of debt to buy companies because it increases leverage levels, something that's not popular with investors.

Additionally, unlike consolidation in Corporate America, REIT mergers don't tend to result in huge cost savings for the combined companies, says Block. For example, if two banks merge, many duplicate functions can be eliminated. “In the REIT industry, you don't really save that much. You save on Board of Directors fees and Sarbanes-Oxley fees, but not a lot,” says Block. “You still need people on the ground to manage and lease properties.”

Although billionaire real estate tycoon Sam Zell, chairman of Equity Office Properties and Equity Residential, has long held the view that REITs will evolve into oligopolies with a few companies dominating the commercial property types, Block remains skeptical.

“Except in the retail area, it really hasn't been demonstrated that a very substantial size combines a competitive edge,” says Block. “The real benefit of size comes with negotiating leverage with your tenants.”

Mall owners with a large portfolio of properties hold a distinct advantage over smaller competitors, Block notes. National retailers in an expansion mode, in some cases rolling out as many as 30 new stores in a year, will pursue owners of large mall portfolios to accommodate their space needs and leasing terms.

Matthew Ostrower, an analyst for Morgan Stanley, characterizes this year's M&A activity as “opportunistic.” He notes that there are about 120 public REITs with market capitalizations of more than $50 million, or about the same number that existed in 1995.

During the past decade, some companies vanished in mergers, while new issues appeared. Public REITs now hold about 10% of all institutional quality real estate, about the same percentage as they owned a decade ago.

While the overall picture has remained somewhat static, mall ownership is far less fragmented than a decade ago. Now about three-quarters of all quality regional malls are in the hands of public REITs, more than double the figure for 1995, says Ostrower.

The impact of Sarbanes-Oxley could play a factor in REIT merger activity going forward. Sarbanes-Oxley has tightened financial reporting standards and imposed expensive new burdens on public companies of all kinds, including REITs, says Dale Anne Reiss, global director of the real estate practice of Ernst & Young. The extra costs could encourage some REIT owners to merge or sell to private investors. “REIT share prices are strong,” Reiss says, “so now is not a bad time sell.”

Paying Too Much?

Perhaps no merger this year created as much buzz as General Growth Properties' acquisition of Rouse. Founded in 1939, Rouse owns 37 regional malls, including such landmarks as Faneuil Hall Marketplace in Boston and Fashion Show Mall in Las Vegas. General Growth chief executive John Bucksbaum says the acquisition will increase the company's economies of scale.

Now the REIT will control 200 malls in 45 states and nearly all the top 20 markets. If a retailer plans to open 60 locations, it may decide to put 20 stores at General Growth malls, says Bucksbaum. “We can offer tremendous efficiencies,” he adds. “A retailer can open at several locations and sign just one lease. That means stores can open sooner.”

Some analysts have questioned the value of the Rouse purchase. They estimate that General Growth acquired the Rouse portfolio at a 5% capitalization rate. While individual properties have traded at that level, few expected to see a multibillion-dollar transaction command such a low yield. Says Ostrower of Morgan Stanley, “It is hard to justify paying that high a price.”

Stan Luxenberg is a New York-based writer. Editor Matt Valley contributed to this report.

SELECT REIT MERGERS AT A GLANCE
Acquirer Target Status Total Value Result
General Growth Properties The Rouse Co. Expected to close 4Q 2004 $12.6 billion Adds 37 malls in key markets such as Denver and Atlanta
Brandywine Realty Trust Rubenstein Co. Closed 9/21/04 $600 million Gains trophy offices in Philadelphia
Simon Property Group Chelsea Property Group Expected to close 4Q 2004 $4.8 billion Gains 35 premium outlet malls
CNL Hospitality KSL Recreation Closed 4/2/04 $2.1 billion Adds six large resorts in Hawaii and the Sunbelt
Eaton Vance/ProLogis Keystone Closed 8/4/04 $1.6 billion Adds industrial properties in key New Jersey market
Source: SNL Financial and company reports