The spate of privatizations within the REIT sector in the past year have impacted the share valuations of a large number of perceived takeover targets so much that REIT boutique Green Street Advisors recently added another step to its net asset value pricing model to factor in probability of a privatization.
Normally, issues such as “takeover roulette” can be dealt with by tweaking the subjective components of a REIT’s franchise score, but this tool can be a bit too crude when a factor is having a sizable impact on numerous valuations, said Mike Kirby, founder of Green Street.
The new step in the model involves assigning a probability to a privatization occurring sometime in the next 18 months and an estimate of the value that might be realized on privatization. In most cases, this value is fairly close to NAV, but it can be lower if high transaction costs are likely or higher if sizable platform value is present, Kirby added.
M&A deals have occurred at a rapid clip in the past year as a result of skewed normal price relationships, and REITs are no longer trading at premiums to NAV, as they typically have.
“Fourteen of the sixty-one companies where we provide NAV estimates are trading at discounts exceeding 8%. Pricing conditions of this sort make the Blackstones of the world drool,” Kirby said.
Pension Funds The Driver
Kirby believes that a major driving factor behind the phenomenon is that after years of paying little attention to real estate, pension funds are now climbing over each other to fill some very large positions. Due to their bureaucratic structures and consultant searches they continue to do the vast majority of their real estate investing via direct vehicles based on the advice of the most popular consultants.
According to the IREI Plan Sponsor Survey, US REITs will be accorded only 5% of the $59 billion of plan sponsor capital flows into real estate this year, with 80% going into direct vehicles. With pension fund real estate allocation growing at a time when traditional REIT capital sources have been experiencing only moderate inflows, the normal relationship between public pricing and private pricing has been thrown off kilter, analysts said.
Ironically, as a result, the REITs that have incorporated joint ventures with pension fund money into their business models, such as Kimco and ProLogis, have enjoyed great rewards from the public markets.
Greenstreet has run the new model on several REITS that they believe are likely having their public valuations impacted by privatization rumors including Highwoods Property, Felcor Lodging, Crescent, Equity Office Properties, and Washington Real Estate.