REIT Consolidation: Aggressive M&A Market To Peak In 2018?

Corporate consolidation through mergers and acquisitions is heating up as real estate firms look for ways to scale and source deals in the current low-yield environment.

Both public-to-public and public-to-private M&As are on the rise, according to data from LaSalle Investment Management Securities, though there is a divide between the number of deals closed so far this year compared to 2017 and the value of those deals. 

Last year, a total of 21 deals were completed compared to the eight that have closed as of June 30 — however, those eight transactions are valued at $65B compared to last year’s total $55B. 

“This year will likely be a peak for this cycle and perhaps even a record year. What’s causing the increase? There are a couple of catalysts,” LaSalle Securities North America Portfolio Manager Lisa Kaufman said during a recent Bloomberg Intelligence webinar about this year’s wave of REIT M&As.

“One is clearly discounted valuations — REITs have underperformed equities and private real estate for the last two years, particularly in the traditional core real estate sectors of retail, apartment and office.”

Ongoing REIT stock underperformance has required board members to become more open to making deals at this late stage in the cycle, in hopes of generating shareholder value and improving stock performance. Such was the case with Blackstone’s acquisition of LaSalle Hotel Properties, announced in May.

Blackstone was but one of a handful of cash-rich suitors that pursued LaSalle Hotel Properties. LaSalle rejected a bid from Pebblebrook Hotel Trust for $37.80/share, instead going with Blackstone’s $33.50/share offer because it was an all-cash deal. 

"Pebblebrook’s proposal, which includes 80% stock consideration, continues to fail to address the significant price risks and uncertainties for LaSalle shareholders that had been previously communicated to Pebblebrook," LaSalle officials wrote in the announcement. Blackstone’s $4.8B acquisition of the Bethesda, Maryland-based REIT, which owns 41 hotels, came only days after the private equity giant agreed to unload its remaining 15.8 million shares in Hilton Worldwide. 

Differing Opinions

Sources told Bisnow there are a number of factors contributing to this year’s aggressive M&A environment.

For one, asset managers find merging with a competitor can be a cost-effective way to increase market share and expand their presence both domestically and globally.

In addition — taking into account the extended period of economic growth the U.S. has been experiencing, exorbitant asset prices and a frustrating bid-ask spread that is making it harder for investors to get the returns they want — there is an excess of dry powder on the market through both debt and equity funds searching for deals. 

“That’s resulting in a strong environment for REIT M&A. Public companies are trading at discounts of [their] net asset value. [This] provides an opportunity for buyers to come in and pay a premium on the existing share price and still pay a price that is at or below the net asset value. That is a compelling opportunity for buyers,” Greenhill & Co. Head of Real Estate Corporate Advisory Adam Troso said.

Public-to-public REIT M&As accounted for 98% of this year's deals, up from the 78% of public-to-public deals closed in 2017, according to data from Nareit.

Wednesday’s announcement of the Phillips Edison & Co. merger is yet another example of industrywide consolidation. Phillips Edison & Co., which is one of the nation’s largest grocery-anchored center landlords, will merge with Phillips Edison Grocery Center REIT II — a REIT it manages internally. The merger will create a $6.3B REIT that will operate 323 shopping centers across 36.7M SF nationally. 

“Some of these are just sensible business deals for building a national platform that helps them improve cost structure and operations,” Nareit Senior Vice President of Research & Economic Analysis Calvin Schnure said.

Prologis, the world’s largest warehouse owner with 683M SF and $81B worth of assets under management, announced plans in April to acquire competitor DCT Industrial Trust for $8.4B, including debt. Once complete, the deal will give Prologis a larger presence in densely populated industrial markets, including San Francisco, Seattle, South Florida, New York and New Jersey. 

Other noteworthy REIT M&As for the year include Greystar Student Housing Growth and Income Fund’s agreement to acquire Education Realty Trust, one of America’s largest student housing REITs with more than 79 communities under its belt, for $4.6B. The cash-and-debt deal marked yet another move by institutional players looking to get into the student housing space. 

Healthcare REIT Welltower Inc. agreed to acquire senior housing REIT Quality Care Properties this year for $2B in cash.

Though a healthy economy and strong U.S. real estate fundamentals have laid the foundation for this year’s active M&A market, some believe the wave of consolidation signals a coming downturn. 

“Anytime business slows down it leads to consolidation,” said Michael Weiser, president of New York real estate services firm GFI Realty. “If you can combine two firms, and maintain your volume while eliminating most of one firm's fixed costs, the post-merger sum of the whole is greater than the parts.”

Uncertainty is also playing a part. Rising interest rates, trade wars and reservations regarding certain global economies is encouraging investors worldwide to look to strong economies for solid-performing assets.

“Let’s remember that real estate, even when it’s local, it’s global,” Weiser said. 

When striking deals, more often than not investors’ capital stacks include debt and equity from both foreign and domestic players, Weiser said. The globalization and institutionalization of real estate has aided the aggressive M&A market as deep-pocketed institutional investors, private equity giants and sovereign wealth funds look to get into the commercial real estate space.

"Real estate is not a purely localized market anymore. The flow of funds is very open … all this stuff comes into play and those are all factors that are contributing towards the slowdown in volume, which leads to M&A.

"Factors coming into play today that didn’t come into play two cycles ago: everything from tax to trade to local economies to whatever country you’re in — going overseas will always yield you some premium,” Weiser said.

Private Equity Giants Gobble Up REITs

Schnure said REITs are experiencing consolidation in a number of ways — some asset managers are merging to establish a national platform, while others are being bought out by private buyers with deep pockets. All of this activity is further evidence that REIT portfolios are strong. 

“This is normal within a growing industry and reflects a high level of confidence in the buildings the REITs own,” Schnure said. “We also are seeing an interest from private equity investors making a number of acquisitions over the last year. There is a lot of capital that the private investors have; they’re saying the REIT assets are good.”

Among the largest deals year to date was Brookfield’s agreement to buy retail REIT GGP Inc. in a $9.25B cash merger that valued GGP at $15.3B. Leading up to the deal, the mall operator had been brainstorming ways to restructure its portfolio to create value for shareholders amid the challenging retail environment. 

GGP CEO Sandeep Mathrani said during an earnings call last year that the company was considering a sale of assets or even privatization after suffering a 50% drop in earnings in Q1 2017. The mall owner rejected Brookfield Property Partners’ first offer of $7.4B, or $23/share, as too low; its second offer of $23.50/share was accepted. Brookfield plans to spin off real estate assets as a result of the deal, creating BPY U.S. REIT.

Another deal signaling private equity’s dominance in the space is Blackstone’s acquisition of Gramercy Property Trust. Blackstone affiliate Blackstone Real Estate Partners VIII agreed to purchase the industrial REIT for $7.6B early this year. The move is one of several recent industrial and logistics plays made by Blackstone in the past year. 

The world’s largest real estate manager is betting big on global logistics and life sciences sectors, Blackstone President and Chief Operating Officer Jonathan Gray said during the Q1 earnings call. The firm, which has $120B in real estate assets under management, believes the two sectors are particularly insulated from rising interest rates.

"We're clearly heading into a rising-rate environment, as we see global economic strength," Gray said. "As investors, that means you need to buy things that will grow faster. In a real estate context, cap rates are likely to go up, so you want to own things in which you see higher earnings growth.”

Private institutional buyers are coming into the deals with cash and taking on less debt, Schnure said, a trend that mirrors REITs themselves. Portfolio managers are restructuring their balance sheets to become less exposed to debt by increasingly lowering their leverage to further insulate themselves from the effects of interest rates.

“We are seeing among these merger deals a caution in how they’re structured,” Schnure said. “The mergers where the private equity is coming in — they’re coming in with cash. This is just very prudent balance sheet management.”