By Burland East, CFA
Flush with record levels of cash, many private capital real estate managers are buying up publicly traded real estate investment trusts ("REITs") to take advantage of the gap between public REITs and private real estate valuations. Historically, commercial real estate in the private market has usually transacted at, or near, fair value (or else the property doesn't trade), while shares of REITs often trade at a discount or premium to their underlying net asset value ("NAV") in the public markets. This is because REIT share prices fluctuate in the public stock market while the underlying real estate NAV remains relatively constant (in the same way private real estate's NAVs do).
Most of the REITs recently acquired by private capital have been trading at a material discount price to NAV in the public market; however, when these discounted REITs are acquired, it is at a price closer to NAV. These REIT acquisitions have been readily agreed to because they can create value for the private capital (who may get institutional-quality real estate relatively quickly, easily and less expensively) and for the REIT shareholders (who may get a nice return from the substantial share price increase from the pre-deal share price). This activity of private capital buying beaten-up REITs can effectively create a put option for the holders of the publicly traded REITs - if the price drops enough, the REIT may be taken out closer to NAV, and certainly at a premium to the discounted pre-deal share price. In addition to creating a price floor for individual REITs, this buying activity can also create a supporting tailwind bid for the entire REIT asset class.
- The current market cap of domestic public REITs is about $1 trillion; the total value of underlying real estate assets is about $1.5 trillion, assuming 33% leverage, which is typical for public REITs.
- As of 6/30/15, private real estate managers had a record $249 billion in unspent capital commitments (this is equal to about 25% of the total public REIT market cap!). Private capital typically employs meaningfully greater levels of leverage than REITs do, which only further increases its REIT-buying power.
- It is generally faster, easier and less costly for private capital real estate managers to buy public REITs than private real estate.
- Private capital can buy a large REIT portfolio in one bite. For example, Excel Trust was recently acquired by Blackstone (NYSE:BX) for approximately $2 billion. The Excel Trust portfolio included 38 retail shopping center properties across 18 states. If Blackstone had to buy these properties in one-off transactions, they would have had to travel to every property, conduct their own data gathering and due diligence, review and audit financials and every lease contract, and successfully create and close potentially 38 separate deals with 38 different parties. It is much easier, faster and less expensive for Blackstone to buy an institutional quality portfolio, already equipped with GAAP accounting, lease abstracts, financial audits, and publicly available granular property level data, in one fell swoop. Not only are transactional costs less, but they may be getting it at an arguably cheaper price.
- In the past year, a number of REITs have been purchased by private capital, including but not limited to the following list:
Investors sometimes pose the question, "Why buy the goods when you can buy the store?" In effect, private capital is answering that question by buying discounted REITS instead of individual properties. Expect this trend to continue as long as REITS trade at material discounts to their NAVs and as long as private capital is looking for ways to deploy nearly $250 billion in unspent capital commitments.