Published January/February 2013
Despite all of the macroeconomic woes of late, from high unemployment to slow growth, listed REITs have fared well in the eyes of investors. The FTSE NAREIT All REITs Index posted total returns of 20.14 percent in 2012.
Listed REITs also offer relatively high yields at a time when interest rates on Treasuries are at historical lows. In fact, for publicly traded REITs, times have rarely been so good: Financing is cheap, many stocks trade at a premium to net asset value and balance sheets remain strong. As a class, they have done much better than their counterparts in private real estate, where financing is harder to come by and many properties remain stuck in a web of workouts and extensions.
The outlook for public real estate is promising for 2013, according to REIT magazine’s latest roundtable with investment bankers. The upshot: REITs should continue to be net acquirers, taking full advantage of their good status with the markets. In health care, the largest players in terms of market capitalization, Ventas Inc. (NYSE: VTR), Health Care REIT Inc. (NYSE: HCN) and HCP Inc. (NYSE: HCP), will likely maintain their acquisition paths, as will companies in richly valued sectors such as net-lease. REITs will tend to buy other private portfolios more than anything else, though a blockbuster M&A deal is always possible. Bankers remain hopeful that IPOs will come back to life and agree that strong balance sheets will continue to benefit REITs in 2013.
REIT: With the economy slowly improving, what is your outlook for commercial real estate M&A volume in 2013 compared with what we saw in 2012?
Scott Schaevitz: We will see volume pick up a bit. There’s still real estate coming loose from lenders and private-equity shops that have held property through the life of the investment. We will also see a fair amount of REITs selling portfolios, with the stock market giving them credit for focusing their strategy and exiting non-core property types and geographies.
Avinash Mehrotra: Conversations we’re having today can manifest themselves into deals six to nine months forward. By that measurement, the level of strategic activity is probably more robust than we have seen since 2008, a low point in the business. Particularly in the second half of 2012, we have seen the level of strategic dialogue pick up dramatically.
Jackson Hsieh: For the most part, I think it’s going to be smaller $1 billion- to $3 billion-sized transactions. Two sectors that will have continued M&A legs in 2013 are the health care and net-lease sectors, which are trading at strong premiums to NAV.
Jeff Horowitz: Volume will increase somewhat materially in 2013. We’ve begun to see our pipeline expand across the board by both property type and type of acquirer, meaning public and private. Public companies have had excellent access to all forms of capital, and certain major private funds have either recently been raised or been able to access the CMBS or bank-lending markets.
Mark Decker: There are not a lot of distressed owners currently, so assets aren’t trading. We’re in a market where debt is still very inexpensive. Of course a large disruption in the capital markets of some kind—such as a geopolitical blowup in Greece or Europe—would have an impact.
REIT: Why have there been so many deals in the health care sector, such as with the acquisitions by the three biggest REITs?
Mehrotra: The three large-cap companies in this sector are competing with one another very aggressively for asset portfolios. Given their size, they’re trying to consistently demonstrate to their investors that they can source and purchase large portfolios at the right prices—and not overpay. These companies have a long runway in front of them. Once they start exhausting opportunities in the United States, they will continue to have international expansion opportunities.
Decker: It’s a huge sector, and with the baby boomers, the demographics are at its back. The large companies are trading at substantial premiums to NAV, making for a lot of compelling deals for the management teams. These companies are happy to use their stock or raise equity capital.
Horowitz: Health care is a particularly large and diverse sector that includes senior housing, medical office, skilled nursing and more, so the level of activity is not a surprise. There also happen to be several CEOs in the sector that have had the conviction to grow, ability to structure transactions favorably and fund them at an attractive cost of capital.
Hsieh: With health care—and also net-lease—what is really driving those sectors is the long-duration, fixed-income profile of what those companies are able to deliver right now. In the low interest-rate environment, that spread is attracting investors.
Schaevitz: You have management teams that have proven themselves to be great value creators for their shareholders. Health care REITs are also in a target-rich environment. There is a very large universe to go after—and these are the best capitalized companies to go on offense.
REIT: Where do the health care REITs outside of the top three stand?
Decker: If you go outside the top three or four, they are also benefiting. They have strong currency, access to capital and good balance sheets.
Horowitz: It’s harder for smaller companies to compete with respect to the more sizable deals, but there should still be ample opportunity for them to grow through more modest, one-off deals.
REIT: Overall, will public REITs be net acquirers or sellers in 2013?
Schaevitz: Net acquirers. With their cost-of-capital advantage, listed REITs are going to be in a very good position to be the winning bidders. There’s still a lot of real estate on the balance sheets of banks and with special servicers.
Hsieh: It is going to be very sector specific. In health care and net-lease, you’ll see net acquiring. Multifamily is still pretty robust. With the economy seeing signs of improvement, hotels in 2013 will be slight net acquirers. In office, there will be net selling. Shopping malls have become very consolidated, so overall you may not see that much activity there.
Decker: REITs will be net acquirers, but they’ll also continue strategic selling. To maximize value, REITs are always looking to replace properties with new assets that have opportunity to grow revenue.
“There happen to be several CEOs in the (health care) sector that have had the conviction to grow, ability to structure transactions favorably and fund them at an attractive cost of capital.”
Mehrotra: The public REITs are probably going to be net acquirers—especially from the private market—because they currently enjoy a lower cost of capital. With interest rates at historic lows and REIT shares trading well, public REITs have the ability to raise debt and equity financing on very favorable terms. To continue to grow, they will use their currency when they are able to do stock deals and their borrowing capacity when they need to do cash deals.
REIT: What sectors, if any, are more prone to take-private transactions?
Schaevitz: Go-private transactions have been quiet for several years, but I expect them to pick up. The primary driver is the return of the CMBS market. Inexpensive CMBS fueled a lot of the acquisitions completed in the last cycle. I do not believe that it is sector specific. It is balance sheet specific.
Decker: If it’s a take-private transaction, that tends to be name specific, either a REIT that stubbed its toe, one that is trading substantially below NAV, or a management team that wants to retire. To the extent we do see this type of activity, it will tend to be mostly smaller market-capitalization companies. But with M&A in general, it will tend to be public-to-public and public acquiring private.
Horowitz: I don’t believe that there will be any one sector particularly susceptible to take-private activity. Instead, private players are looking to purchase established platforms with strong management teams, where add-on acquisitions are possible, and that have strong leveraged yields. In terms of size, I believe most of the transaction activity will be in the $750 million to $2.5 billion range.
REIT: What does the development picture look like across the commercial real estate space?
Mehrotra: We haven’t seen a lot of new development capital. The one part of real estate where I think financing remains a little tougher to find is what we call transitional plays, where you are developing an asset today with cash flows that will come online in the future. That market still remains a bit fragile.
Horowitz: My sense is that development pipelines will most likely remain muted for quite some time, with the greatest levels in the public multifamily companies, and particularly in the bigger markets. Construction financing remains challenging for all but the strongest private developers, and certainly for the public companies.
Schaevitz: Development has picked up, but it is still a small number compared with historical averages. I am not concerned about finding the market massively overbuilt anytime soon. In this part of the cycle, REITs have the advantage, since the list of lenders for private developers has shrunken terribly. So, there is less capital available to private developers, leaving more opportunities to the well-capitalized firms.
REIT: And what about IPOs, will there be an uptick in this area?
Hsieh: It hasn’t been the most robust market for REIT IPOs. One of the deals we worked on, Spirit Realty Capital Inc. (NYSE: SRC), a net-lease company, was a relatively large size IPO, in the $500 million range, and it traded up over the offering price. That is a good thing.
“Debt is cheap, and REITs have fortress-like balance sheets. REITs are very healthy.”
If we have more examples of companies that go public, deliver on their management strategy and deliver a return, hopefully that will be a positive for more quality companies to look to enter the public markets.
Decker: We need new capital sources. I think the lack of capital is a real issue for the industry. The traditional REIT buyers—institutional investors—are still there, but they are looking for large, liquid IPOs at very deep discounts. It’s a difficult market today, but a lot of high-quality, smaller companies are looking hard at accessing public capital. There are also new sectors emerging, such as energy infrastructure. Also, the future move toward privatization of municipal and government assets could accelerate public offerings.
REIT: REITs have had strong balance sheets, but what’s in store for 2013 with more debt maturing?
Horowitz: I believe that despite the low-rate environment, most companies will continue to deleverage slightly and do so in the context of match-funding acquisitions by issuing stock. Beyond that, each company may begin to take different tacks, given their views on the global markets, funds flow and cost of capital.
Hsieh: The public companies are in really great shape. The more pressing problems are on the private side, where you have borrowers with loans that are clearly in excess of the value of the property right now. There will continue to be more of that activity of restructuring workouts with the servicers, but you have to come up to that maturity window for something to happen.
Mehrotra: Since 2008, there has been a deleveraging across all categories of REITs. Even now, REITs seek leverage-neutral deals, such as HCP’s 2012 acquisition of a $1.7 billion portfolio from a Blackstone-Emeritus joint venture, where HCP raised $1 billion of equity capital to finance the purchase. That is a healthy forward sign for the sector.
Decker: Debt is cheap, and REITs have fortress-like balance sheets. REITs are very healthy. They survived the great crash of 2008 because they had reasonably strong balance sheets to begin with, and they have only gotten stronger.
Schaevitz: Almost any REIT loan maturing in the next year has plenty of sources for refinancing. The unsecured market is very strong, with a good pace of issuance at tighter spreads. For those who do not have access to the unsecured market, there is a very active CMBS market. There are also balance sheet lenders, who will lend both secured and unsecured.
REIT: With such strong balance sheets, how will REITs use available capital in 2013?
Schaevitz: There are plenty of acquisition opportunities. REITs have proven they can buy assets from less sophisticated owners and reposition those properties. They have a track record of improving the cash flows and property values.
Hsieh: Public REITs will continue to buy private portfolios, just like the health care sector. The trend will persist. There will be selective companies that evaluate an IPO. Malkin Properties is one higher-profile example, and there are other companies doing so.
Horowitz: REITs have been and will likely continue to be disciplined with their capital. Most REITs will selectively make acquisitions and will proactively manage their debt maturities. REITs will likely refinance existing securities as soon as they are callable and extend maturities to the fullest extent that makes economic sense.
Charles Keenan is a regular contributor to REIT magazine.