REIT IPOs: The Wave Before the Surge

by: Brad Case

An article published on Tuesday by Elizabeth Juge of SNL focused on the REIT IPOs completed during 2010 as well as those that were terminated. REITs that accomplished successful IPOs were Chesapeake Lodging Trust (NYSE:CHSP); Piedmont Office Realty Trust (NYSE:PDM); Terreno Realty (NYSE:TRNO); Chatham Lodging Trust (NYSE:CLDT); Excel Trust (NYSE:EXL); Hudson Pacific Properties (NYSE:HPP); Whitestone REIT (NYSEMKT:WSR); CoreSite Realty (NYSE:COR); and Campus Crest Communities (NYSE:CCG).

Successful IPOs get a lot of attention, but equally interesting are the companies that try to do an IPO but can't quite pull it off. Juge's article listed CapitalSource Healthcare REIT; Pyramid Hotels & Resorts; Welsh Property Trust; Callahan Capital Properties; Halvern Realty; Clearview Hotel Trust; Americold Realty Trust; and NorthStar Healthcare Investors. Twelve other REITs were listed as having announced but not yet completed IPOs: Verde Realty; Reunion Hospitality Trust; Younan Properties; DLC Realty Trust; Legacy Healthcare Properties Trust; STAG Industrial; Preferred Apartment Communities; Summit Hotel Properties; Richmond Honan Medical Properties; ECM Realty Trust; American Assets Trust; and Eola Property Trust.

Why do IPOs fail? There are many reasons, but two are especially relevant to investors in the current market.

First, some of the failed IPOs were for "blind pool" REITs that hope to gain access to capital for real estate investing, but do not yet own any assets. That means investors have to judge the quality of the management team and its business plan without having any evidence as to how well that management team has executed its real estate investment mandate in the past. That's not necessarily a problem--some blind pool REITs are going to be very successful--but it exposes potential investors to a lot more uncertainty.

The second problem is the focus of another article, by Arleen Jacobius of Pensions & Investments, very widely read and highly respected in the institutional investment community. (It's summarized in an equally good article, "Forecasting an IPO Flurry," by Tom Yeatts of SNL; Jacobius's article, unfortunately, is available only to subscribers.

"Everybody wants to be a REIT," said Jacobius.

Jacobius quoted Bank of America Merrill Lynch's Ron Sturzenegger as saying there are roughly 12 REIT IPOs on file or waiting to launch. Sturzenegger said some sponsors are looking to take once-public private companies public again. Real estate money managers are after public companies' easy and cheap access to capital.

What she's saying is that dogs try to pass themselves off as diamonds to escape their earned oblivion--that's the motivation behind some announced IPOs, and when the dogs are exposed, that's the reason for their failure.

The problem is that many real estate investment managers on the private side of the market bought their assets at the peak of the market (2006-2008) using too much leverage. They've essentially lost everything on behalf of their investors, and are facing exposure. (I've highlighted this situation in several articles, including here.)

One way to escape their fate would be to launch an IPO, which, if successful, would get them the cash they need to avoid defaulting on their debt--but would leave IPO investors holding the bag of over-leveraged properties with high purchase prices (and therefore poor prospects for capital appreciation).

Meanwhile, publicly traded REITs have a pretty sizable competitive advantage, because they have access to capital during a market phase in which access to capital will go a long way toward determining who wins big and who's left wishing.

That's why there is likely to be a continuing parade of attempted IPOs, many of which will be successful--but many others of which shouldn't, and won't. It's just that it's up to investors to figure out which are the diamonds and which are the dogs.

Any discussion as to how investors should go about that?

Disclosure: I am long the Vanguard REIT Index Fund. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: The opinions expressed in this post are my own and do not necessarily reflect those of the National Association of Real Estate Investment Trusts ((NAREIT)). Neither I nor NAREIT are acting as an investment advisor, investment fiduciary, broker, dealer or other market participant, nor is any offer or solicitation to buy or sell any security investment being made. This information is solely educational in nature and not intended to serve as the primary basis for any investment decision.