The collapse of Lehman Bros, which precipitated the global financial crisis, has left the company with very few options. As part of its bankruptcy restructuring it has decided to sell one of its most prized possessions, its real estate division Archstone Enterprises to two REITs AvalonBay Communities (AVB) and property tycoon Sam Zell's Equity Residential (EQR), in a $6.5 billion cash and stock deal.
According to the deal, Equity Residential will acquire 60% of Archstone while the rest will be taken over by Avalon Bay. The two will also take over Archstone's $9.5 billion in debt. Lehman acquired the firm for $15.5 billion, excluding its $6.9 billion debt, just months before the real estate collapse. The irony here is that the massive size of the Archstone deal and its poor timing played a crucial role in Lehman's collapse. Now, that same Archstone will please Lehman's creditors as the company is getting a 17% premium over what it had valued Archstone at previously.
Lehman will receive $2.69 billion in cash and will have a 13.2% and 9.2% stake in AvalonBay and Equity Residential. This will make the Lehman estate the single biggest shareholder of AvalonBay and Equity Residential. The transaction will close within the next four months and does not require any approvals from the shareholders of either of the two buyers. Equity Residential will sell 19 million shares while AvalonBay will sell equity to finance the deal.
The deal is a great catch for the two buyers who will now add tens of thousands of new apartments to their portfolio - both will get more than 20,000 units each ---in the recovering Washington real estate market. According to Delta Associates, Washington has added 11,068 apartment units in the year ending June 2012, which is more than double compared to last year. However, prices have been falling while rents are on the rise. Delta also noted that the prices for apartment units are down 5% and 13.1% for high-rise and low-rise properties. In the meantime, the vacancy rates will continue to decline from the current 4.1% to 3.9% by the end of 2013 while rent is expected to increase from 4.1% to 4.6% next year.
Despite Lehman's fall, Archstone has always attracted investors' attention due to its portfolio of 57,948 apartment units in the metropolitan areas in Northeast, California and southeast Florida. Lehman was itself gearing up to either sell or IPO Archstone. Lehman purchased the stakes in Archstone held by Bank of America and Barclays for $2.88 billion, which paved the way for this sale.
The First Trust S&P REIT (FRI) and Shares Dow Jones U.S. Real Estate ETF (IYR) have been up 11.8% and 13.94% from January till December 3rd. Both have gone neck to neck with SPDR S&P 500 ETF (SPY) which is up by 12.7% in the same period. Both ETFs represent AvalonBay and Equity Residential but their biggest holding is Simon Property Group (SPG), the biggest REIT in the U.S. with a market cap of $47 billion, more than twice as big as AvalonBay or Equity Residential. But unlike the latter two, Simon Property focuses on shopping malls and due to its relatively lower P/E and much higher returns, has been investor's favorite.
Investing in the commercial REIT market in the U.S., however, is premature given that there is still significant risk of further liquidation of the retail sector. Between the potential disaster of the fiscal cliff, the need for the Fed to monetize the mortgage-back security industry and the collapse of major retailers like J.C. Penny (JCP) and Best Buy (BBY) it is hard to see that we are close to a turnaround in U.S. real estate. Prices may not fall much more from here but they are not likely to rise much either in the near future. What is happening in the E.U. now will begin to engulf the U.S. even more so in the coming months. Blackstone Group is putting a full court press on Asia, Hong Kong and Singapore, in particular. I would follow them.