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Picking up the pace

Close to $30 billion in REIT deals were announced in 2001, and this year should bring more of the same.

Close to $30 billion in REIT deals were announced in 2001, and this year should bring more of the same.

By Howard Rudnitsky
May 2002
Institutional Investor Magazine

The collapse of both the Russian ruble and Long-Term Capital Management in 1998 froze the capital markets and pretty much halted all real estate investment trust financing , including M&A. Deals worth $31 billion closed that year, second only to 1997's record of $37.9 billion. It was all downhill from there. The low point for REIT M&A came in 1999, when just $14.4 billion in deals were completed.

Last year , despite the recession and the market jitters that followed September 11 , saw a surge in M&A, as $29 billion worth of deals were announced, reports Charlottesville, Virginia,based research firm SNL Financial. Will 2002 yield a new record?

It's not likely. Although M&A got off to a solid start in the first quarter, with about $7 billion of activity, most REIT stocks are now selling near their all-time highs. Through April 24, REIT shares had risen by some 6 percent, resulting in an overall 5 percent premium to net asset value. A potential buyer would have to think twice about paying a premium to NAV.

It's also the case that last year's volume, though nearly 45 percent higher than that of 2000, was less robust than it appears. Just 20 REIT deals were announced, versus 34 in 1998. Of those, two high-profile acquisitions accounted for more than half the dollar value. Last July Equity Office Properties Trust, a publicly traded REIT, acquired San Francisco,based Spieker Properties, another public company, for $7.3 billion. And in December General Electric Capital Corp. agreed to acquire Security Capital Group, a diversified real estate securities holding company, for $8 billion. Both of these huge transactions were done for modest discounts to net asset value.

Those unions were unusual in more than their mere size. Each brought together two public companies, exceptions to the recent trend of public-private mergers, reports SNL Financial senior real estate editor Keith Pomroy.

Pomroy projects that the pickup in M&A volume should continue over the next couple of years. Driving volume will be strong share prices, which can be used for acquisitions of private companies, real estate assets or other public REITS. Multiples rose to 9.3 times funds from operations in 2001, from 8.1 times FFO in 2000.

Are shareholders long-term winners in these deals? Mike Kirby, a partner at Newport Beach, California,based Green Street Advisors, a real estate research firm, takes a dim view of many of the transactions. "The bad news is that there's no evidence that these mergers create any value. On the other hand, the good news is that there isn,t any evidence that value is being destroyed."

A recent study by the Chicago real estate investment firm K.G. Redding and Associates confirms Kirby's view that in many instances the mergers wind up being a wash. Interestingly, for the 18 months ended February 28, the 15 largest REITs, which did most of the buying, produced total returns of only 21 percent. By contrast the 40 small equity REITs with market capitalizations under $200 million, which mostly avoided deal-making, generated 30 percent,plus returns.

Michael Mueller, a director and REIT analyst at CIBC World Markets Corp., expects that more publicly traded real estate companies, facing limited internal growth prospects, will move to acquire private real estate assets as a way to boost earnings. In March, for example, publicly traded New Plan Excel Realty Trust closed on a

$654 million deal for the 92-shopping center portfolio of CenterAmerica Property Trust, which was majority-owned by a Morgan Stanley real estate fund. And in the fourth quarter of last year, PS Business Parks, a public REIT, bought $200 million of privately held business park properties.

Such deals do not go unnoticed within the tight-knit industry. "A lot of companies that weren,t in the game before are now in the game," says Mueller.