WILLIAM M. McLAUGHLIN
Big-company stocks ‘clobbered’
Rising interest rates and a cooling housing market did little to deter real estate investment trusts as they outpaced most stocks in 2006 while investors concentrated much of their capital into office and multifamily portfolios.
“The stocks of the big public companies who build single-family homes have gotten clobbered,” said William M. McLaughlin, senior vice president of development at Avalon Bay Communities, a Virginia-based REIT with offices in Boston. “But the multifamily, office and mall markets are strong and the REITs stock reflect it.”
A REIT is a tax designation for a corporation investing in real estate that reduces or eliminates corporate income taxes. REITs offer a way to invest in real estate in the same way mutual funds provide investment in stocks.
REITs delivered a total return of 36 percent through November, surpassing the Standard & Poor’s 500 (14 percent), the Dow Jones Industrial Average Index (13 percent), the Russell 2000 (17 percent) and NASDAQ (9 percent), according to a year-end report from the National Association of Real Estate Investment Trusts.
Last year featured the biggest display of mergers and acquisitions in the REIT industry’s 46-year history. From January through November, there were 37 M&A transactions compared to nine in all of 2005 and six in 2004, according to NAREIT. Momentum for acquisitions and privatization was especially strong among companies that specialize in office properties, the trade group found. REITs own more than $475 billion of commercial real estate assets.
The largest deal was the purchase of Trizec Properties by Brookfield Properties Co. and Blackstone Group for $4.8 billion. At the time of the acquisition last summer, Brookfield was a giant office landlord with 48 million square feet of space in 67 properties nationwide.
In August, Morgan Stanley Real Estate agreed to buy Glenborough Realty Trust for $1.9 billion. While Glenborough is not among the largest office REITs – it owns 45 office properties totaling about 8 million square feet in Boston, California, New Jersey and Washington, D.C. – Morgan Stanley offered more than the public market valuation, paying 8.2 percent above Glenborough’s closing price before the deal.
The purchase came on the heels of another August acquisition by Morgan Stanley. In that deal, the investment giant bought Saxon Capital, a residential mortgage REIT, for $706 million.
Not all the deals were done on U.S. soil. Among the biggest deals that stretched across the pond included Archstone-Smith’s acquisition of Deutsche WohnAnlage GmbH for $649 million last summer. At the time of the purchase, the German company owned 7,604 housing units located near shops, public transportation and parks in more than 50 German communities.
For Archstone-Smith, which recently opened Archstone Boston Common, a luxury apartment building near the Hub’s Downtown Crossing, the deal represented an increase of its position in the German market. Archstone purchased a 657-unit apartment portfolio in Berlin earlier in the year and an 822-unit portfolio in Mannheim late in 2005.
No Complaints
It appears that nothing could slow REIT deal-making in 2006. Nearly every month there were examples of one REIT absorbing another, or a group of investors succeeding in their bid to take a listed REIT private, according to a NAREIT analysis.
The reasons for a strong business climate for M&A activity among REITs are similar to the consolidation in the retail and banking industries. The acquiring companies want enhanced market share, or economies of scale that come with a larger portfolio, or an expanded reach in specific geographic areas.
While 65 percent of M&A deals in 2006 were among public companies, privately held companies also were targeted. Additionally, REITs’ privatization was brisk in 2006, with a number of factors converging to drive deals, according to observers.
As home and condominium sales suffered last year, soaring REIT stock prices in the face of such a downturn is not unusual, say experts. In the late 1990s, for example, investors avoided REIT stocks while housing fundamentals remained strong. In the last recession, fundamentals weakened but REIT prices rose. Real estate stocks typically don’t trade tied to underlying valuations, experts say.
Privatization also has other perceived investor benefits, both financially and, in some cases, regulatory. Once private, ownership is typically free to pursue expansion through higher leverage than public owners can use.
It is unclear whether the momentum of this year’s wave of acquisitions can continue into 2007. Some say that M&A activity in various property sectors probably will continue, but there are doubts about whether there will be quite as many large deals as 2006.
The Standard & Poor’s Industry Investment Reviews has a “neutral” outlook for residential REITs in 2007. The softening housing market has dramatically slowed the number of rental units converted into condominiums, according to S&P. Many previously converted units could return to the rental market, thereby increasing supply, S&P said.
S&P also forecasts a slowing economy in the months ahead, largely induced by the housing slump and slower consumer spending. As a result, renters may be less willing to accept rent increases as the year progresses, S&P said.
Still, S&P said the fundamentals for residential REITs are positive in the long term. It forecasts a gradual decline in housing starts through 2009, as well as steady growth in homebuying due to increased immigration.
Analysts say the prolonged REIT rally is poised to continue, so long as the economy remains healthy and interest rates relatively low. Many predict that the trend toward privatization will carry through 2007 as well – or at least as long as private groups increase their commercial real estate allocation.
While Avalon Bay did not figure into the largest deals of 2006, they had a “robust year,” according to McLaughlin, who said the company has seven apartment complexes under construction in Massachusetts totaling $475 million.
“We have nothing to complain about,” he said.
