An extract from The Real Estate M&A and Private Equity Review, 5th Edition
Overview of the market
The covid-19 pandemic has had a profound impact on the commercial real estate industry, including REITs and real estate private equity. In addition to health and safety issues, many REITs and real estate private equity portfolio companies (and assets) have been confronting difficult issues involving liquidity, rent collection, dividend payouts, disclosure and guidance, among many other things. Strategic planning and risk management have required intense focus, as some business models have been challenged by the pandemic or its resulting acceleration of technological change, including increases in e-commerce and remote working, and decreases in travel, leisure and activities that require congregating in concentrated spaces. There is very limited visibility into how long the pandemic will last and what its long-term impact might be, which makes risk management and strategic planning very difficult but also essential.
Prior to the current crisis, the REIT sector in the United States expanded dramatically over the past quarter century. Until the 'REIT Revolution' of the 1990s, private sources of capital dominated the US commercial real estate industry, and publicly traded real estate vehicles such as REITs played a relatively small role. The tables have now turned, and public REITs are dominant in a number of sectors and show every sign of continuing to grow.
US REITs today own approximately US$2 trillion of commercial real estate, and the industry's equity market capitalisation is approximately US$1 trillion. There are now approximately 121 REITs in the United States with a market capitalisation of over US$1 billion, and 26 of those are over US$10 billion. Compare this to 1995, when the entire market capitalisation of the US REIT industry was just US$57.5 billion, and there were only six REITs with a market capitalisation over US$1 billion.
In addition to growing in size, US REITs have also broadened their reach in terms of asset classes and have begun to expand geographically outside of the United States. While REITs traditionally owned office, multifamily, retail, industrial and lodging assets, today REITs extend across an array of non-traditional sectors, including telecommunications, healthcare, timber, data storage, outdoor advertising and gaming.
Along with REITs, private equity (PE) funds have also become dominant institutional players in US commercial real estate over the past 20 years. In 2008, real estate PE funds raised over US$130 billion per annum, and PE funds have continued to raise large amounts of capital (reaching over US$150 billion in 2019), and have been the architects of some of the largest recent M&A deals in the real estate sector. While international institutional investors have had exposure to the US real estate sector for many years, sovereign wealth funds and other sources of international capital have demonstrated increased interest in the US real estate sector, including through joint ventures with US-based REITs and PE funds.
As noted earlier, the severe economic fallout caused by the sudden spread of covid-19, widespread shelter-in-place orders and the ongoing uncertainty as to the shape the recovery will take has had a significant impact on REITs, igniting a plethora of firestorms around tenant, employee, operational, health and safety issues, rent collections, and liquidity and capital concerns. Market dislocations resulting from the pandemic, particularly in those subsectors that have been hit the hardest, have also presented openings for opportunistic investors and strategic buyers to acquire high quality assets at significant discounts. Activists and opportunists may seek to capitalise on the situation, particularly if as the recovery takes shape their targets lag behind others.
Prior to the crisis, technological change continued to drive significant activity for REITs and real estate PE funds, and it remains to be seen whether the recent disruptions caused by the pandemic, and the evolving manner in which people use and interact with various forms of real estate, will further and more permanently accelerate this trend. REITs that harness the technological momentum or provide the infrastructure for the new economy, including data centres, cell towers and logistics facilities, are likely to continue to grow rapidly. On the other hand, traditional retail REITs and REITs in other disrupted sectors will need to work hard to adjust to the new environment through restructurings, redevelopment and other changes. Already, four of the 10 biggest REITs are tech REITs, and the trend shows no sign of slowing.
Recent market activityi M&A transactions
Recent M&A activity has been focused primarily on PE funds' acquisitions of public REITs (public-to-private transactions) and combinations of REITs (public-to-public deals), with REIT spin-offs and restructurings to unlock the value of corporate real estate also playing a role. The take-private transactions have been driven largely by PE firms' belief that their target REITs are trading at a discount to the value of their assets, thus providing an opportunity to profit from the arbitrage. The public merger transactions, on the other hand, have been a function of the continuing consolidation in the various REIT sectors in order to create scale, benefit from synergies and carry out strategic growth plans, among other reasons.ii PE transactions
PE firms have been increasingly active in real estate M&A, driven by large pools of capital-seeking deals. In particular, factors such as higher valuations in the private real estate markets than in the public REIT markets, inexpensive and plentiful debt, and highly liquid private markets that facilitate exit opportunities, have driven a number of REIT privatisations, including the following transactions:
- Brookfield Asset Management acquired Forest City Realty, which owned apartment buildings, shopping centres and other assets, in an all-cash transaction valued at approximately US$11.4 billion in December 2018. The price represented a 26.6 per cent premium for the target's stock, and the agreement had a break fee of US$261 million and a reverse break fee of US$488 million. The acquisition followed years of pressure from activist investors at Forest City, ultimately leading to the elimination of the company's dual class voting structure, which reduced the founding family's control over the company and paved the way for an acquisition.
- Blackstone purchased Gramercy Property Trust, an owner and manager of industrial commercial real estate, in October 2018 in an all-cash transaction valued at US$7.6 billion. The price represented a 15 per cent premium for the target's stock, and the agreement had a break fee of US$138 million (or US$46 million under certain circumstances) and a reverse break fee of US$414 million. Additionally, while not a take-private of a public REIT, in September 2019 Blackstone completed its purchase of assets comprising approximately 179 million square feet of warehouse space from GLP, a Singapore-based developer of logistics properties, for US$18.7 billion in one of the largest-ever private real estate transactions globally. The transaction nearly doubled the size of Blackstone's US industrial footprint and is emblematic of its long-term bet on logistics-related spaces, which it expects to benefit from growing e-commerce demand.
- Greystar Real Estate Partners acquired Education Realty Trust (EdR), one of the largest developers, owners and managers of collegiate housing communities in the US, for US$4.6 billion in cash in September 2018. The price represented a 13.6 per cent premium for the target's stock, and had a break fee of approximately US$118 million and a reverse break fee of US$200 million. In connection with the acquisition, funds associated with Blackstone acquired EdR's student housing portfolio for US$1.2 billion in cash.
- Brookfield Asset Management purchased GGP Inc, the then-second largest owner of mall space in the US, in which Brookfield was a dominant investor, in August 2018 for approximately US$15 billion in cash and stock, a premium of approximately 20 per cent to the price of GGP's stock prior to widespread rumours of Brookfield's interest. The agreement had a break fee of US$400 million and a reverse break fee of US$1.2 billion.
- Blackstone purchased Excel Trust, which owned shopping centres and other retail assets, for about US$2 billion in July 2015. The deal represented a 15 per cent premium for the target's stock, and had a US$25 million break fee (if the target terminated the transaction to take a superior proposal) and a reverse break fee (payable by the acquirer in the event the deal was not completed under certain specified circumstances) of US$250 million.
- Lone Star Funds acquired Home Properties, an apartment REIT, for US$4.4 billion in October 2015. The deal represented a 9 per cent premium for the target's stock, had a US$150 million break fee and had a reverse break fee of US$300 million.
- Blackstone purchased Strategic Hotels and Resorts, an owner of luxury hotels, for approximately US$6 billion in December 2015. The deal represented a 13 per cent premium for the target's stock, and had a US$100 million break fee and a reverse break fee of US$400 million.
- Blackstone also acquired BioMed Realty Trust, which focused on office space for pharmaceutical and biotechnology companies, for US$8 billion in January 2016. The deal represented a 24 per cent premium for the target's stock, and had a US$160 million break fee and a reverse break fee of US$460 million.
REIT mergers may be motivated by the advantages of scale, including a potentially lower cost of capital, to benefit from synergies or to garner other benefits of consolidation. Major recent REIT mergers have included:
- Simon Property Group Inc's acquisition of Taubman Centers, Inc and an 80 per cent ownership interest in The Taubman Realty Group Limited Partnership in an all-cash transaction valued at US$9.8 billion (announced February 2020);
- Prologis, Inc's acquisition of Liberty Property Trust in a stock-for-stock transaction valued at US$13 billion (February 2020);
- Park Hotels & Resorts, Inc's acquisition of Chesapeake Lodging Trust for US$2.6 billion in cash and stock (September 2019);
- Cousins Properties' acquisition of TIER REIT, Inc, a US$7.8 billion cash and stock transaction (June 2019);
- Government Properties' US$1.2 billion all-stock merger with Select Income REIT, with the combined company renamed Office Properties Income Trust (December 2018);
- Pebblebrook Hotel Trust's acquisition of LaSalle Hotel Properties for a mix of cash and stock that valued LaSalle at US$5.4 billion. The acquisition represented the conclusion of Pebblebrook's nine-month pursuit of LaSalle, which terminated its original agreement with Blackstone in order to accept Pebblebrook's topping bid (November 2018);
- Taylor Morrison Home Corporation's acquisition of AV Homes, a cash and stock transaction valued at approximately US$963 million in enterprise value (October 2018);
- Annaly Capital Management's acquisition of MTGE Investment Corp, a transaction valued at approximately US$900 million in equity value (September 2018);
- ProLogis' acquisition of DCT Industrial Trust, a US$8.4 billion stock-for-stock transaction, including the assumption of debt (August 2018);
- Welltower's acquisition of Quality Care Properties and Quality Care Properties' acquisition of HCR ManorCare at the completion of HCR ManorCare's Chapter 11 bankruptcy process, a transaction valued at approximately US$3.9 billion (July 2018);
- Penn National Gaming's acquisition of Pinnacle Entertainment, a transaction valued at approximately US$2.8 billion in enterprise value (October 2018);
- Kennedy-Wilson Holdings' acquisition of Kennedy Wilson Europe Real Estate Plc, creating a leading global real estate investment and asset management platform with a US$8 billion enterprise value (October 2017);
- Digital Realty Trust's acquisition of DuPont Fabros Technology, a transaction valued at approximately US$7.8 billion in enterprise value (September 2017). DuPont Fabros shareholders received shares of Digital Realty in the merger;
- Sabra Health Care's acquisition of Care Capital Properties, creating a combined healthcare REIT with a pro forma total market capitalisation of approximately US$7.4 billion and an equity market capitalisation of approximately US$4.3 billion (August 2017). Care Capital Properties shareholders received shares of Sabra Health Care in the merger;
- Regency Centers' acquisition of Equity One, creating a combined shopping centre company with a total market capitalisation of approximately US$16 billion (March 2017). Equity One was merged into Regency, and its stockholders received shares of Regency in the merger;
- Annaly Capital Management's acquisition of Hatteras Financial Corp, a transaction valued at approximately US$1.5 billion in equity value (July 2016). At their election, Hatteras stockholders received shares of Annaly common stock or cash, or both, in the merger;
- Starwood Waypoint Residential Trust's acquisition of Colony American Homes and internalisation of its manager, creating a combined company, renamed Colony Starwood Homes, with a combined asset value of approximately US$7.7 billion (January 2016). Starwood Waypoint Residential Trust and Colony American Homes shareholders received shares of Colony Starwood Homes in the merger;
- Chambers Street Properties' acquisition of Gramercy Property Trust, creating an industrial and office net lease company with an enterprise value of approximately US$5.7 billion (December 2015). Gramercy stockholders received shares of Chambers Street in the merger;
- Washington Prime Group's acquisition of Glimcher Realty Trust, a transaction valued at approximately US$4.3 billion (January 2015). Glimcher shareholders received shares of Washington Prime and cash in the merger;
- Essex Property Trust's acquisition of BRE Properties, creating a multifamily apartment company with a market capitalisation of US$15.4 billion (April 2014). BRE shareholders received Essex stock as well as cash in the merger; and
- American Realty Capital Properties' acquisition of Cole Real Estate Investments, creating the largest net lease REIT with an enterprise value of US$21 billion (February 2014). Cole stockholders received American Realty Capital Properties stock or cash in the merger.
In situations where real estate owned by an operating non-real estate business would have a higher valuation if held in a REIT, or where separation of the real estate has other advantages, a company may consider strategies to unlock this value. REIT spin-offs and other separations are complex, and may or may not make sense depending on a variety of factors. Recent transactions of this kind include the following:
- Penn National Gaming separated its casino assets into a REIT, Gaming and Leisure Properties, which then leased most of these assets back to Penn National. Shares of the REIT were distributed to Penn National shareholders through a tax-free spin-off in November 2013.
- Sears Holdings sold and leased back 235 of its owned retail assets to a newly created REIT, Seritage Growth Properties, and distributed rights to acquire shares of Seritage to Sears' shareholders in July 2015. The transaction allowed Sears to realise US$2.7 billion in value for the assets funded through the rights offering and financing on the assets.
- After Pinnacle Entertainment announced that it was planning a tax-free spin-off of its real estate assets, Gaming and Leisure Properties made an offer for Pinnacle's real estate assets. After adjustments to the offer and further negotiations between the parties, Pinnacle spun-off its operating assets into a separate public company and merged with a subsidiary of Gaming and Leisure Properties in April 2016, and shareholders of Pinnacle received shares of both the new, spun-off operating company and Gaming and Leisure Properties.
The rationale for typical REIT spin-offs is to provide the market with a more focused, targeted investment opportunity by separating elements of the parent company's property portfolio into a new, independent REIT. Major recent REIT spin-offs have included the following:
- Simon Property Group's spin-off of its shopping centre business and smaller malls into Washington Prime Group (May 2014);
- Vornado's spin-off of its shopping centre business into Urban Edge (January 2015);
- Ventas' spin-off of its skilled nursing portfolio into Care Capital Properties (August 2015);
- Vornado's spin-off of its Washington, DC assets into JBG Smith Properties (July 2017); and
- DDR's spin-off of its lower-quality US strip centres and its Puerto Rico portfolio (announced December 2017).