During the early 1990s, private real estate companies with large portfolios rushed to become public real estate investment trusts. Now the pendulum has swung. In the past two years alone, eight public REITs have sold to private investors.
Recent transactions include Gables Residential Trust, which was sold to ING Clarion for $2.8 billion, and Prime Group Realty Trust, which went to Lightstone Group for $900 million.
“The market moves through cycles. Sometimes it makes sense to go public, but right now there are incentives to go private,” says Mike Acton, director of research for Boston-based AEW Capital Management, which manages assets for major pension funds and other institutions.
Both buyers and sellers have compelling reasons to complete the deals. Because of market conditions, some public REITs are having trouble growing through acquisitions.
At a time when prices for quality properties routinely smash records, REITs have limited ability to match the bids of aggressive private buyers, which can use leverage of up to 100%. Public REITs have less flexibility because shareholders often resist efforts to take on heavy debt loads.
The challenge for REITs has become especially pronounced in the apartment sector. In hot markets, developers are bidding aggressively to buy apartments and convert them to condominiums. That has left public apartment companies with little room to grow.
A REIT that acquires rental apartments may only be willing to accept a capitalization rate — or initial return on its investment — of 7%, says Timothy Welch, executive managing director of broker Cushman & Wakefield. “There are plenty of condo converters who will pay much higher prices and take cap rates of 5%,” says Welch.
If property prices remain steep, as many analysts expect, then the public REITs could face limited growth prospects for the next two or three years. That could erode share prices. “If you expect your stock price to go down, then it could be a good time to sell,” says Richard Imperiale, portfolio manager of Forward Uniplan Real Estate Fund.
Private buyers have been willing to pay a 20% premium for REIT stocks with plans to aggressively cut costs. A middle-sized public REIT must spend about $1 million a year meeting government rules and complying with terms mandated by Sarbanes-Oxley legislation, says Welch of Cushman & Wakefield. Those costs virtually disappear when the REIT goes private. In addition, the owner of the merged company can save millions in salaries through layoffs of non-essential employees.
Are the buyers paying too much? That's a relative question. In the 1990s, some acquirers of public REITs paid premiums of 30% or more. Today, such high prices are considered excessive and likely to dilute earnings of the acquirer.
In some cases, the public REITs are worth extra because they have unusual portfolios, says Imperiale of Forward Uniplan Real Estate Fund. For example, when DRA Advisors paid $3.4 billion for Capital Automotive REIT, the buyer acquired 347 properties that included real estate used mainly by the 100 largest auto dealers in the 50 biggest metro markets.
“These are trophy properties that are worth a premium,” emphasizes Imperiale. “You could work 10 years to build a comparable portfolio and not be able to match the REIT's quality.”
PUBLIC TO PRIVATE
Sarbanes-Oxley and slow growth make the private sector appealing to some REITs. The following REITs went private in 2005.
|AMLI Residential||$2.1 billion||Morgan Stanley|
|Capital Automotive||$3.4 billion||DRA Advisors LLC|
|CRT Properties||$1.7 billion||DRA Advisors LLC|
|Prime Group Realty Trust||$900 million||Lightstone Group|
|Gables Residential Trust||$2.8 billion||ING Clarion|
|*Includes assumed debt|
|Source: SNL Financial|