When General Electric agreed to buy office real estate investment trust (REIT) Arden Realty for $3.2 billion last Thursday, the deal capped a heady year for REIT mergers. Not only is southern California-based Arden the eighth publicly-traded REIT to be sold this year in roughly $20 billion worth of deals, but it’s also further evidence that institutional capital still has a huge appetite for real estate. December proved to be an especially active month for REIT mergers: Centerpoint Properties Trust was sold to a joint venture earlier this month for $2.4 billion.
“The Arden transaction provides GE with an established portfolio in a strong office market,” wrote analyst James Sullivan of Prudential Equity Group in a research note following the announcement. “Market sources suggest that historically high levels of capital continue to search for real estate assets and find public REIT portfolios attractive options for investment.”
GE plans to sell 13 Arden properties to another office REIT, Trizec Properties. That disposition will yield $1.6 billion, which is equal to the amount of debt that GE will assume to buy Arden. The Arden portfolio consists of 19.2 million sq. ft. of suburban office buildings located across Los Angeles, San Diego and Orange County.
More than two-thirds of Arden’s 2004 net operating income (NOI) was derived from its Los Angeles properties. The Southern California office market has been buoyed by strong job growth in recent years, and that activity has helped cut office vacancy in markets such as Los Angeles to below 10% , as of November, according to Grubb & Ellis.
Assuming that the Arden transaction closes, there will be just two major office REITs with portfolios located entirely in Southern California. They are Kilroy Realty Corp. and Maguire Properties, which own more than 20 million sq. ft. of office properties in and around the Los Angeles market. Sullivan of Prudential believes that investor interest in both Maguire and Kilroy is likely to heat up in 2006 given both REITs’ focus on the Southern California market and the absence of Arden.
And, aside from the enticing Southern California office market, he sees other advantages to snapping up REITs, too: “The REITs offer sizable, regionally-focused portfolios with seasoned regional leasing and management teams,” says Sullivan, who predicts that M&A activity will continue to be strong in the first half of 2006. REITs with market capitalizations under $3 billion and portfolios in strong markets will be targets.
What does this portent for small public REITs? “As evidenced by the pricing on the Arden transaction—a 3% discount to the December 22 close—we believe that current level of REIT multiples reflects the acquisition potential and that REIT multiples should return closer to historical multiples once demand from private investors for real estate subsides.” In other words, it’s a good time to sell.