11/27/2012 | by Carisa Chappell

Multifamily REITs AvalonBay Communities Inc. (NYSE: AVB) and Equity Residential (NYSE: EQR) have joined forces to purchase Archstone Inc. from Lehman Brothers Holdings Inc. for $6.5 billion in cash and stock. AvalonBay will acquire 40 percent of Archstone and Equity Residential will get the remaining 60 percent of the company, according to a Nov. 26 announcement.

The news came on the heels of Lehman Brothers' Nov. 19 announcement that it planned to raise up to $3.45 billion in an initial public offering (IPO) of Archstone.

"Archstone had been on a path to come public through an IPO, but the underperformance of apartment REIT shares during 2012 appears to have convinced the parties controlling Lehman's assets to sell Archstone to the most logical buyers," noted Andrew McCulloch, managing director with Green Street Advisors.

Year-to-date total returns for apartment REITs through Nov. 26 were 1.32 percent, according to data from the FTSE NAREIT U.S. Real Estate Index Series. Returns for all U.S. equity REITs were 15.20 percent for the same time period.

McCulloch said that while Equity Residential has been pursuing Colorado-based Archstone for the past year, AvalonBay had been less aggressive. It made AvalonBay's involvement in the deal a surprise, according to McCulloch.

Tim Naughton, AvalonBay's CEO and president, explained that the deal offered a "rare opportunity to acquire a high-quality portfolio of apartment communities concentrated in our markets."

David Neithercut, Equity Residential's CEO, said in a conference call that his company chose to partner with AvalonBay because it sought "a strategic partner, with complementary interests." Neithercut said Archstone's assets will "fit in perfectly" into the company's portfolio and help improve the overall quality of Equity Residential's assets.

"Furthermore, by funding much of this acquisition with proceeds from the sale of assets in our non-core, exit markets, we are accelerating the completion of the total transformation of our portfolio," he said.

R.J. Milligan, analyst with Raymond James, noted that Equity and AvalonBay were always the only two potential strategic partners "with the balance sheet strength and operating scale to pull off such a complex transaction."

Under the agreement, Equity Residential will acquire 78 properties that consist of 23,110 apartment units. AvalonBay will purchase 66 apartment communities that include 22, 222 apartment homes. AvalonBay's acquisition includes six communities under construction.

"This acquisition accelerates our strategic growth vision of more deeply penetrating our core, high barrier-to-entry coastal markets," said Naughton.

Richard Anderson, analyst with BMO Capital Markets, commented that both REITs' exposure to the Washington market will increase.

"It's a great geographic fit for both," he said. The deal eliminates "a major overhang," according to Anderson.

"The optimal window was closing on an Archstone IPO, in our view," he said. "The associated equity issuance from Equity and AvalonBay can be thought of as the IPO in a more efficient and timely form."

The transaction is expected to close in the first quarter of 2013.