Mergers involving real estate investment trusts ground to a halt in the aftermath of the Great Recession. Now, though, REIT deals are back, as evidenced by New York alternative-asset giant Blackstone Group’s three recent acquisitions.
The buying spree is largely driven by the mismatch between REIT shares and the underlying value of their properties. REITs traded at an average discount of 13 percent as of October 1, according to real estate research firm Green Street Advisors, which estimates the value of the properties in a REIT’s portfolio and compares that total with the company’s market capitalization. The discount was even bigger a few weeks earlier: It neared 20 percent during the market swoon of August and September, but REIT prices have bounced back a bit since then.
The gap has emerged because landlords’ stocks haven’t kept pace with the soaring value of commercial properties. By Green Street’s reckoning, capitalization, or cap, rates — a widely followed valuation measure that divides a property’s annual income by its purchase price — are at near-record lows, reflecting rich valuations.
“The market is skeptical about property prices,” says Peter Rothemund, senior analyst for quantitative analytics at the Newport Beach, California–based firm. “Investors are saying, ‘We’re not sure about that 5 or 6 cap. Let’s apply a haircut.’”
There’s nothing new about REITs trading below the value of their underlying assets, notes David Shulman, senior economist with UCLA Anderson Forecast, a think tank at the University of California, Los Angeles: “The market is a forward-looking mechanism, and the net asset value is a current measure.”
Some REITs trade at especially steep discounts, Green Street reports. Among the biggest: 48 percent for mall owner CBL & Associates Properties of Chattanooga, Tennessee; 40 percent for Columbus, Ohio–based retail landlord WP Glimcher; 38 percent for FelCor Lodging Trust of Irving, Texas; and 37 percent for Philadelphia-headquartered Pennsylvania Real Estate Investment Trust.
Green Street calculated takeover odds for REITs and found that some are likely to be acquisition targets. For instance, the firm says First Industrial Realty Trust, a Chicago-based owner of warehouses, has a 50 percent chance of being bought, although wide anticipation of the bid has led to a comparatively slim discount of 4 percent.
A cheap stock doesn’t turn a landlord into an automatic takeover target. The REIT structure makes hostile takeovers difficult, in part because it typically forbids any shareholder to own a stake of more than 9.9 percent. Even so, the discounts have led to an increase in merger activity. Blackstone, with $334 billion in assets, said on October 8 that it would pay $4.8 billion for BioMed Realty Trust, a San Diego–based landlord to biotechnology companies.
The previous month, Blackstone announced it would buy Strategic Hotels & Resorts of Chicago for about $4 billion. Earlier this year the firm closed on its $2 billion purchase of Excel Trust, a shopping center landlord based in San Diego.
Blackstone will probably look beyond the short-term discount with an eye toward repackaging the REITs for public offerings five years from now, says Richard Moore, managing director and analyst at RBC Capital Markets in Solon, Ohio.
“We’ve got a very pricey environment for individual assets,” Moore explains. “At the same time, the stock market in general has backed off, and the REIT stocks have gone down with stocks. The question is, Which one is wrong?”
Both answers might be right in their own way. Equity and property investors follow different valuation approaches. “Eventually, REITs will go back to net asset value,” Green Street’s Rothemund says. “I just don’t know if that’s REIT share prices going up or property prices coming down.”
Moore says he’s not concerned that commercial real estate may be in a bubble. Although cap rates are near record lows, ten-year Treasuries are also at rock bottom levels.
“If I had these cap rates and interest rates were at 6 percent, I’d be very afraid,” Moore says. “But interest rates are at 2 percent, so I don’t think there’s any issue here.”
In the meantime, Rothemund can only scratch his head at some transactions. He points to a $2.3 billion investment by Chicago property investor Heitman and Singaporean sovereign wealth fund GIC in stakes in several malls owned by Macerich Co. of Santa Monica, California, at a 4 cap, even though Macerich shares trade at a 5 cap. “They could have bought the stock for 20 percent less,” Rothemund says.
UCLA’s Shulman sees one obvious way for REITs to play the discount: purchasing their own shares on the cheap through stock buybacks. “If you’re a REIT, why buy an asset you don’t know at 100 cents on the dollar when you can buy assets you do know at 90 cents on the dollar?”
But Moore of RBC worries that buybacks put REIT managers into a stock trader’s role when they should be sticking with operating real estate. What’s more, devoting cash to buybacks can leave a REIT without cash for property acquisitions.
“It’s absolutely the worst thing to do,” Moore contends. “What happens if you buy shares today and the market corrects 10 percent?”
