In spite of raising record amounts of cash through secondary equity offerings over the past year, publicly traded REITs will largely stay away from merger and acquisition activity in the near term, according to a panel at NAREIT’s REIT Week in New York City.
Perhaps having learned the lessons from the previous decade, when a large number of REIT mergers led to over-leverage and, in some cases, bankruptcy, today REIT managers view mergers and acquisitions principally as business decisions with serious long-term repercussions, rather than purely financial plays, these experts say.
As a result, in spite of having the capital to chase new deals, REITs will pursue only those transactions that make sense on a long-term and operational basis.
“I am not sure we’ll see [a high] level of activity,” noted Matthew Lustig, vice chairman of U.S. investment banking and head of real estate with Lazard Feres & Co. LLC, a financial advisory and asset management firm. “The market is driven by strategic transactions. Our view is there are certain combinations that will make sense, but it’s a strategic, not a financial decision.”
Perfect timing?
At first glance, today’s market environment would seem to be perfect for mergers and acquisitions in the REIT sector. In 2010, U.S. REITs raised $23.6 billion in secondary equity offerings, outpacing the previous seven years, according to NAREIT figures. Year-to-date in 2011, the industry has raised an additional $16.8 billion. Many of the REITs now find themselves in a position where they are ready to seize opportunistic transactions and may be able to acquire smaller rivals with desirable portfolios.
This has also been a period of relative stability in REIT share prices, which would make completing stock-to-stock transactions easier, according to Adam Emmerich, partner with Wachtell Lipton, Rosen & Katz, a global law firm specializing in mergers and acquisitions, strategic investments and takeovers.
Plus, post-recession periods have historically been good times to complete mergers because many companies are looking to expand. Mergers allow newly combined REITs to take advantage of their shared property platforms, noted Walter Rakowich, CEO of ProLogis, a San Francisco-based REIT that specializes in developing and operating industrial real estate. (For its part, ProLogis just finalized a merger with AMB Property Corp.)
In addition, today there may be opportunities for publicly traded REITs to acquire private entities. Companies that have found it too onerous to complete IPOs over the past 18 months might consider mergers with public peers to be an attractive way to raise capital, according to Emmerich. Many of the firms that aspired to undergo IPOs in 2010 and 2011 have had to adjust initial share prices, and also face pressure to reduce leverage levels beyond what management may feel comfortable with.
“When you contribute property to a REIT, what you are doing is you are taking an interest in a pool of similar properties that you can evaluate with a great deal of transparency and certainty and taking an x number of shares [in such a transaction] is very different from other industries,” Emmerich said. “It’s a lot more convenient than doing an IPO.”
Long-term decision
The catch is that successful REIT mergers are the result of long-term research and happen because the companies involved feel there is a fair amount of synergy between their operations and revenue streams, according to Rakowich.
Debra Cafaro, chairman and CEO of Ventas Inc., a Chicago-based healthcare REIT that this year bought Nationwide Health Properties Inc. for $5.7 billion, noted that Ventas reviews potential acquisition opportunities on an annual basis, even when it has no plans to pursue a deal. This allows the company to thoroughly research its rivals and to keep its board of directors in the loop in case the timing seems right to make a move.
“I really believe the board should not be hearing about a merger,” just as the company is about to enter the bidding process, Cafaro noted. “These discussions go back five to 10 years.”
Mergers and acquisitions also entail major changes for REITs’ senior management staffs, which means that personnel have to be informed of upcoming transactions in advance and be on board with the decisions, Rakowich added. All of this means that experienced REIT operators won’t pursue mergers just because the market seems ripe.
“The stars really have to align,” according to Rakowich. “This merger [with AMB] was different because it was a merger of equals.”
Minor exceptions
Nevertheless, the REIT industry might see some merger and acquisition activity over the next year, involving primarily private equity buyers and large U.S. REITs expanding on a global scale. Today, many private equity players are looking to invest in class-B assets in secondary markets that the top REITs might find too risky, according to Lustig. That might create an opportunity for private equity investors to buy firms that specialize in those kinds of properties, and today the cost of capital is low enough to make such deals work.
“I think you will see more deals from private equity. The only thing that scares you about that is debt,” Lustig said.
In addition, many REITs want to grow their portfolios outside the U.S. and as part of that expansion strategy, they might find it more prudent to invest in an overseas partner rather than buy or develop properties on their own.
“As a corollary of greater global activity by U.S. REITs, you will also see greater acquisition activity,” according to Emmerich.