Why Public REITs are Going Private

Maybe the grass really is greener on the private side of the market. There has been a noticeable uptick in the number of publicly traded REITs being snapped up by private buyers this year. And there are several reasons behind the phenomenon, among them the swelling coffers of private-equity funds and the growing perception that life as a private company may be a lot easier for a REIT operator as the public’s ardor for REIT shares cools.

So far this year, five public REITs were sold to private investors for a total of $10.9 billion. Last year, by comparison, only three public REITs went private, fetching a combined $2.6 billion, according to SNL Financial. That $10.9 billion is a tiny sliver of the roughly $300 billion public float of equity REITs. But observers say that more such transactions are likely, as private investors — including private REITs and REOCs — are willing to pay as much as 30% premiums to stock prices before the deal.

With a dearth of better investment choices to consider, investors are pouring money into both public and private real estate firms. This has driven listed share prices up, and that has led many analysts to downgrade a good number of listed REITs, which they say have become too pricey. The common refrain: Shares are still trading at a premium of as much as 20% to their net asset values, or even after a year of mediocre returns (Yesterday, NAREIT reported that its index of public REIT shares had fallen by 2.7% in the month of October and is up only 4% for the year).

“The analysts have really missed the boat on this one,” says Han Nordby, a research strategist at Boston-based Property & Portfolio Research. These public REITs, he says have more than asset values for buyers: They come with strong management teams and operating companies. “While REITs, as a whole, should act largely like the underlying real estate over time, there are a lot of moving parts here,” he says.

That helps explain why private buyers are increasingly targeting small and medium-size public REITs. Last Monday, for example, AMLI Residential Properties Trust was sold to a private Morgan Stanley investment fund for $2.1 billion. The sale price represented a 20.7% premium over AMLI’s closing share price prior to the deal. The apartment REIT owns 75 luxury apartment complexes in the Southeast, Midwest and mountain regions where it also is developing another five projects made up of 827 units.

Prime Property Fund, the buyer, owns a $4.5 billion diversified portfolio of core properties in major U.S. markets. Prime Property prevailed over a field of 9 bidders to snap up AMLI. None of the bidders, incidentally, was a public REIT. The AMLI management team will also remain intact after the sale, according to Morgan Stanley.

That sale capped one busy fall season of similar deals. DRA Advisors LLC, a pension fund advisor that bought office REIT CRT Properties for $1.7 billion in September, announced a second deal to take a Capital Automotive REIT private for $3.4 billion. Capital Automotive is a retail REIT that focuses on auto dealership properties.

For management of a public REIT, the buyout can make sense. Going private now takes away the pressures of public ownership as commercial property markets become more challenging. Even as the boom cycle shows signs of slowing, the public REIT universe has grown; there are now more than 200 listed public REITs in existence, up from 187 at the beginning of 2004.

As these companies jockey for deals to deploy capital, asset prices continue to rise and cap rates are falling across real estate classes, making it harder and harder to generate the returns that public shareholders demand. Private-equity funds with money from institutions and wealthy individuals have longer time horizons, however. And, private real estate firms can use leverage more freely than their counterparts in the public sphere, giving them added financial clout to bid on pricey deals.

Bruce Schonbraun, a managing partner at New York-based real estate consulting firm Schonbraun McCann Group says he expects more such deals, as long as private equity players believe they can get superior returns in commercial real estate. Even if they are not putting themselves up for sale, he notes, publicly traded REITs are obligated to entertain reasonable offers. “And,” he notes, “It’s hard to resist changing from public to private when you can sell at such a premium.”