REITs have been turning to joint ventures (JVs) for years as a means to extend their balance sheets, moderate leverage, execute on strategic endeavors, and earn fees to enhance returns. Today’s environment of tighter capital markets and market volatility, though, is expected to generate even more consideration of JVs across the REIT industry.
Daniel LeBey, a partner at Vinson & Elkins, says there has been a pick-up in JV activity in the last two to three years, “which I think is at least in part a reflection of the difficult conditions in the public equity capital markets during that period.”
That appetite to establish JVs isn’t likely to diminish anytime soon. “We are heading into a more distressed environment in the commercial real estate sector generally with higher rates, lots of debt coming due, and tighter lending policies at the banks. This will force owners to look at other capital sources,” he adds.
Although JVs are attracting more attention, there is still a disconnect in the valuations of the real estate that can create an obstacle for partners to come to terms. “Once that gap closes, and it does feel like it is starting to close, JVs can be really useful tools for REITs as an alternative,” says Stacey McEvoy, a partner at law firm Hogan Lovells.
JVs in Action
Earlier this month, Apartment Income REIT Corp. (NYSE: AIRC) announced JV commitments valued at $1.2 billion with two of the world’s largest real estate investors to reduce the REIT’s indebtedness and fund accretive acquisitions.
Matthew O’Grady, AIR’s senior vice president for capital markets, says the company is always engaged with private capital sources, but began talks in earnest once public markets started trading lower over the last 18 months. He notes that in the institutional and sovereign space today there are a limited number of institutions looking to deploy capital. “Those investors who are active are focused on partnering with great operators on whom they can rely on to drive operating performance year in and year out.”
Not only do the JVs offer AIR an attractive source and cost of capital, they allow it to partner in buying undermanaged properties to generate excess returns, all the while retaining highly valuable properties and great people servicing our residents,” O’Grady says.
Meanwhile, Summit Hotel Properties, Inc. (NYSE: INN) embarked on its first joint venture in 2019 when it didn’t have the cost of capital it needed to continue pursuing external growth opportunities. That was the genesis of its partnership with Singapore’s sovereign wealth fund GIC that has since grown to a portfolio of 40 hotel properties and nearly $1.5 billion invested – with more runway ahead for acquisitions.
The timing of the Summit-GIC joint venture turned out to being incredibly advantageous. Summit had the liquidity to take advantage of a huge opportunity set that emerged during the pandemic, including the 27-property NewcrestImage portfolio for $822 million. “There is no question that it has been a wonderful vehicle for us, and there is scale that has been added to the business that we wouldn’t have otherwise been able to achieve without the partnership,” says Jonathan Stanner, Summit’s president and CEO.
The way a REIT approaches a JV, and how it negotiates terms, depends on the goal. In some cases, a REIT might be looking at a JV purely as an alternative to the debt markets to finance growth, or it might be considering a JV as a way to monetize existing assets to create liquidity, McEvoy says.
For example, BXP (NYSE: BXP) has two separate strategies when it comes to joint ventures. In some cases, the REIT will engage in a JV deal for deal access, such as partnering with a landowner on a development. A second strategy that BXP has been focused on over the past decade is partnering with institutional capital, such as Norges, GIC, the Canada Pension Plan Investment Board, and others.
However, BXP is adapting to the realities of new market conditions in structuring those deals. “Return expectations are definitely in flux, meaning that they're higher but there is still some uncertainty around what they need to be to attract an investor to deploy capital,” says James Magaldi, senior vice president of finance and capital Markets at BXP. Given the cost of debt, it is not surprising that institutional capital has higher yield expectations, and there is some price discovery that's necessary in order to figure out what's the appropriate attachment point or return.
For office properties in particular, there also is the added stigma attached that is influencing risk-return expectations. Institutions are making investments in office, but on a highly selective basis, Magaldi says. “When I say highly selective, it means the projects need to be essentially de-risked to achieve the core to core plus type of return, which in this current environment is now at 7% to 8% for something that was more like a 5% to 6% return pre-pandemic,” he says. BXP is still getting interest from institutional capital partners. However, pricing is challenging due to the dysfunction in the capital markets and macroeconomic headwinds.
“We have a significant amount of capital that we want to deploy, as do a lot of these institutional groups, and yield expectations are higher for both owners and institutional capital,” Magaldi says. Since these investors are looking at higher-yielding alternatives, it’s a matter of incentivizing them to co-invest with BXP. “On the surface, our premier workplaces are a great opportunity for them. But they're evaluating it in the context of how they can get a more accretive yield doing something else that might be a higher risk profile,” he says.
Strategies for Structuring Deals
The three most important aspects to think about when embarking on a JV partnership are the economics, the exit and transfer mechanics, and how the partnership is managed, according to McEvoy.
First, do the economics match up with what you’re expecting to see out of the performance of the asset? Are there other fee streams that a partner is realizing from the asset? Those different components help determine whether a JV is a more attractive alternative to the debt markets or other sources of funds, because there also are soft costs to managing a joint venture partner to consider, she says.
Second is the transfer and exit mechanics. A public REIT that is going into a JV is going to be very focused on whether they do a corporate-level transaction. “In that case, you don’t want the tail to wag the dog,” McEvoy says. “So, it is important to make sure that you have the appropriate carve-outs to take part in that corporate level transaction without having to go through your partners in the joint venture.”
A third consideration focuses on how a JV is managed. Who is managing it, how is it managed, and what are the checks on that management? In addition, there are other considerations, such as tax and accounting considerations, that may impact how a joint venture is structured.
JVs can be structured for a single asset or portfolio of assets, or in an open-ended or programmatic way, which can lead to more capital from the JV partner as needed. “Generally, public REITs do not want to cede control over their assets, so JVs undertaken by REITs are more likely to be true partnerships where the REIT maintains either a majority or near majority of the equity,” LeBey adds.
For example, the Summit-GIC joint venture is structured with Summit as a 51% controlling general partner and GIC as a 49% minority partner. Summit also gets paid certain fees for services it provides to the JV as the general partner. “We set it up with very limited parameters intentionally,” Stanner says. There is no minimum or maximum investment threshold. There are some time parameters within the venture, but it can go as long as the partners want it to continue.
“For us to find a joint venture partner, we needed it to be as opportunistic as it possibly could be. We didn’t want to be a forced buyer or forced seller of assets,” he adds. So, putting fewer governors around what the joint venture looked like from a size and asset type perspective was important to us, he adds.
Summit also is mindful of how large that JV becomes as part of its overall company. Summit owns 100 hotels today and 40 are in the JV. “We still feel good about our ability to grow within the venture,” Stanner says. “But we are cognizant of creating an inverted ownership or inverted capital structure with a JV that becomes the majority of our asset holdings.”
We're comfortable doing more JV transactions going forward…because at the end of the day, it'll help us scale up and access more interesting opportunities.
Finding the Right Partner
REITs agree that it is so important to find the right partner. “Finding a partner that is philosophically aligned with how you think about creating value is really important,” Stanner says. GIC is a great fit, he adds, because they tend to be a long-term holder of real estate and a lower levered buyer of real estate.
In addition, there is flexibility within the venture to pursue various types of assets, whether strong cash-flowing assets or deep turnaround renovation or repositioning, he says. Having GIC as a partner also lends credibility to the Summit platform from a deal perspective and with lenders. “There are all kinds of knock-on effects and benefits of having such a high quality partner,” Stanner says.
AIR’s O’Grady adds that “if you look at AIR’s roster of joint JV partners, it very much validates what we're doing with our business. We're comfortable doing more JV transactions going forward…because at the end of the day, it'll help us scale up and access more interesting opportunities.”
Meanwhile, different aspects of structuring JV deals can get tricky, whether it is negotiating an exit or agreeing on major decisions. Oftentimes, the biggest risk is being aligned with somebody that doesn't share the same view.
“In this environment, everybody's really finding out who their friends are, and whether they are truly like-minded. So, everyone is thinking about being partnered up with the right people, which is where we always start,” Magaldi says. For BXP, that means partnering with long term investors who have a more conservative view on taking risks relative to their investments, he adds.
Investors are also interested in partnering with experienced owner/operators to deploy capital. However, investors also are more critical of who they’re partnering with in the current environment where there are more economic challenges and risks.
There are plenty of investors who are just waiting to find the right valuation that fits their own modeling. However, it is about finding the right partner too, McEvoy notes. Even a relatively short-term joint venture is likely to last a couple of years. So, both sides have to trust that the other side is going to behave in the manner in which the relationship helps the joint venture the most, she adds.