Interest Rates, Mergers, and Privatization Dominate REIT Headlines for 2015

This article is republished with permission from REITCafe.

Real estate investment trusts (REITs) ended the year with a total return of 3.13 percent. The FTSE NAREIT All REIT Index outpaced the Dow Jones Industrial Average, S&P 500, and Russell 2000 Total Return Index for the year, but lagged the NASDAQ’s gain of about 8 percent.

The market in 2015 was characterized by strong market fundamentals and high property valuations—both a positive and negative for REITs.

Healthy demand for all types of space led to higher revenues and improved REIT profitability; rising property values created an attractive environment for sales. But high property valuations also made acquisitions difficult and left many REITs considering alternatives for expansion. Most REITs increased their development and bolstered their redevelopment pipelines. However, continued strong demand leads few to believe that markets are becoming overbuilt.

Some REITs grew through large portfolio acquisitions, such as the joint purchase of KTR by a joint venture of Prologis and Norges Bank Investment Management.

Interest rate fears created a misalignment in the market in which REITs were trading below net asset value—a situation different from previous misalignments because this year’s pullback did not reflect concern about an imminent weakening of market conditions. Interest rate uncertainty lessened in December when the Fed announced an increase in its benchmark interest rate, citing confidence in the U.S. economy as the impetus for the hike.

The door for activity in REIT initial public offerings was open early in the year, but had closed by midyear as stocks wavered in anticipation of higher interest rates. The industry eventually expanded through spin-offs and conversions through much of the year.

Merger activity between REITs increased because buying shares was less expensive than purchasing individual assets. Notable moves include Weyerhaeuser’s purchase of Plum Creek Timber and Gramercy Property Trust’s merger with Chambers Street Properties.

Activist investors also made their mark on the industry in 2015, encouraging a wide variety of companies to spin off retail properties into REITs. Sears formed Seritage Growth Properties, and Darden Restaurants formed Four Corners Property Trust. However, Macy’s and McDonald’s elected not to pursue REIT spin-offs. In September, the Internal Revenue Service halted approvals of further spin-offs while it studied tax implications. In December, the U.S. House of Representatives passed legislation that will remove the tax advantages of spinning off corporate real estate into REITs.

Privatization was another 2015 trend in response to REITs trading below net asset values. Deals were announced between Campus Crest Communities and Harrison Street Real Estate Capital, BioMed Realty Trust and Blackstone, and Strategic Hotels and Resorts and Blackstone. In addition, Lone Star Funds acquired Home Properties, Brookfield Asset Management acquired Associated Estates Realty, and Blackstone acquired Excel Trust.

Worldwide economic issues and global terrorism weighed on markets in 2015, creating concern that the U.S. economy could be dragged down as a result. Global money seeking a safe haven in the United States also contributed to higher property valuations, especially for iconic assets in larger markets.

A few roadblocks that could derail the economy are on the horizon. The U.S. commercial real estate market anticipates a few near-term threats. The impact of rising interest rates on REITs will depend on how far and fast rates rise. Loan borrowing will become more expensive and potentially more difficult, which could affect the ability of REITs to expand. In addition, higher interest rates could spur investors that had been attracted to REITs for their yields to pull money out in favor of other investments.

* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com.

** - 10 yr. Treasury Yield as of 12/11/2015.