Get ready for a wave of takeovers of U.S. publicly traded landlords.
Real estate investment trusts — companies that own properties such as luxury hotels, office towers and shopping malls — are trading at an almost 15% discount to what investors would pay for buildings individually, according to Green Street Advisors LLC. The gap, the biggest in five years, has been growing since May, pushing the odds of REIT buyouts to the highest since 2006, the property-research firm's data show.
That means acquisitions such as
Blackstone Group LP's $3.93 billion deal for Strategic Hotels & Resorts Inc. and its interest in buying BioMed Realty Trust Inc. may mark the beginning of a REIT-takeover acceleration. Bargain prices are a lure for opportunistic buyers sitting on piles of cash who can snap up entire companies, then sell them off in pieces or build businesses around their existing infrastructures.
“If I'm a fund and still have money to put to work, it's better to go buy at a discount and have a platform in place,” said Lukas Hartwich, an analyst at Newport Beach, Calif.-based Green Street.
Since April, there have been $12 billion of takeovers of publicly traded REITs,
Green Street data show. That doesn't include Blackstone's pending acquisition of Strategic, an owner of hotels including the Ritz-Carlton Half Moon Bay in California and Manhattan's Essex House. Prior to the $763 million purchase of AmREIT Inc. last year — the only one in 2014 — such deals had been at a standstill since the $20 billion takeover of apartment landlord Archstone-Smith Trust in 2007.
BIOMED SUITOR
BioMed, a San Diego-based REIT focused on laboratory and medical office space, is considering a sale, and Blackstone is a potential suitor, people familiar with the matter said this week. The stock has under-performed other REITs in the past year.
REIT stocks have been pummeled by the same issues shaking markets around the world, including China's economic slowdown and a rout in commodity prices. But real estate shares have been hit harder because of investor concern that interest rates, once they increase, will be a drag on property values and make it more expensive for REITs to raise money.
The Bloomberg REIT Index is down 15% from an eight-year high, reached in January, compared with a 6.1% decline for the Standard & Poor's 500 Index in the same period. Property stocks got a temporary boost last week when the Federal Reserve held off raising its benchmark lending rate for the first time in nine years.
The REIT selloff is an overreaction when the performance of U.S. commercial real estate is considered, said Rich Moore, an analyst at RBC Capital Markets in Solon, Ohio. The fundamentals that support property values, such as occupancy and rental rates, haven't deteriorated, he said. Additionally, the deep well of capital that has been raised for property purchases should provide a buffer against a minor increase in interest rates, he said.
'HIGH PRICE'
“It doesn't strike me that there's an issue in commercial real estate,” Mr. Moore said. “The office building in San Francisco trading at a very high price has nothing to do with oil prices.”
U.S. property values are breaking records after a five-year recovery from the financial crisis. Prices for buildings in big cities such as New York and San Francisco are 30% higher than they were at the previous peak in 2007, according to Moody's Investors Service and Real Capital Analytics Inc.
As real estate values climb, so does the likelihood of REIT buyouts as long as share prices continue to underperform property prices. More than half of publicly traded REITs have at least a 10% chance of being bought out, according to Green Street. The portion of REITs with those odds reached a high of 80% in 2006.
REITs that own hotels look especially cheap relative to the value of the properties they own, making them an attractive target, according to Mr. Hartwich of Green Street. Sunstone Hotel Investors Inc. and DiamondRock Hospitality Co., both trading with a 25% discount to their asset values, have takeout odds of 30%, Green Street data show.
HIT HARDER
“Hotels are just more economically sensitive,” Mr. Hartwich said. “When you have some jitters in the market, that tends to hit the hotel sector harder.”
Representatives for Sunstone and DiamondRock didn't return telephone calls seeking comment.
While a large discount in share prices relative to property prices will attract buyers, it may also mean real estate values are poised to fall, said Andy McCullough, a Green Street analyst. In the run-up to the property-market crash in 2008, there was a rush of REIT takeovers. The public market is often a good indicator of what will happen in the private market, Mr. McCullough said.
“It's right more often than it's wrong,” he said. “When you see discounts this large, it should make real estate investors a little nervous.”
ACTIVIST INVESTORS
One new factor leading to more REIT purchases is the rise of activist investors such as Jonathan Litt, co-founder of Land & Buildings Investment Management. Agitating by Mr. Litt, who had criticized Associated Estates Realty Corp.'s share performance and urged it to find a buyer, was a likely catalyst for the landlord's August sale to a unit of Brookfield Asset Management Inc.
The large discounts priced into REIT shares don't mean management should automatically succumb to suitors, said Mr. Litt, who targets firms with issues such as poor management that can be fixed. But if the disconnect persists, there will be more deals, he said.
“The public markets are weak on concern about interest rates, and this will likely correct itself,” Mr. Litt said. If not, “good companies will go private.”
