This article is republished with permission from REITCafe.
Back to the Future Day—marking the day, October 21, 2015, when characters in the 1989 movie Back to the Future Part II arrived when traveling forward in time—took place last week. Real estate investment trusts (REITs) are also experiencing a “back to the future” moment.
It is not the first time REIT values have pulled back while underlying real estate values are healthy and rising, causing some to trade below net asset value. Despite currently healthy real estate market conditions, investors are pricing an anticipated market slowdown into REIT share values. This situation generally occurs late in the real estate cycle and is spurring REIT privatizations and share buybacks.
| TREPP-i Survey Loan Spreads (50–59% LTV)* |
| This Week | Previous Week | Previous Month | End 2014 | End 2013 | |
| Industrial | 175 | 173 | 165 | 138.5 | 170 |
| Multifamily | 170 | 168 | 161 | 139.8 | 166.7 |
| Office | 185 | 181 | 173 | 148 | 175 |
| Retail | 175 | 173 | 165 | 139.8 | 175 |
| Average Spread | 173.75 | 174 | 166 | 141.5 | 171.7 |
| 10-year Treasury Yield** | 2.08 | 2.02 | 2.16 | 2.17 | 3.04 |
The current situation is different from previous market misalignments because this year’s REIT pullback is largely the result of interest rate uncertainty rather than imminently weakening market conditions. No one knows when interest rates will rise or how far or fast they will increase, but REITs are especially sensitive to their movement. Meanwhile, underlying real estate market fundamentals are strong and many believe that the outlook for the next 24 months is bright. Vacancies have fallen and new supply is low, giving owners pricing power with rents. Yet, the FTSE NAREIT All Equity REIT average has climbed only a modest 2.60 percent so far this year.
In response, several REITs have announced privatization plans this month. Student housing REIT Campus Crest Communities became the latest REIT to privatize, with an announcement October 16 that private equity firm Harrison Street Real Estate Capital will acquire it in a $1.9 billion deal. Earlier this month, private equity firm Blackstone Group announced an $8 billion deal to acquire BioMed Realty Trust (BMR). Blackstone is also acquiring Strategic Hotels and Resorts in a $6 billion deal announced in September.
Several privatizations announced earlier in the year were completed in recent months. The $7.6 billion acquisition of apartment REIT Home Properties by Lone Star Funds closed in October; the $2.5 billion sale of apartment REIT Associated Estates Realty to Brookfield Asset Management was completed in June; and the $2 billion acquisition of retail REIT Excel Trust by Blackstone Group closed in late July.
An increasing number of REITs have determined that buying back shares at discounted values is a better use of funds than investing in high-priced acquisitions and have instituted share repurchase programs. In September, Fitch Ratings reviewed second-quarter 2015 earnings calls for 80 REITs and reported that 28 of them—35 percent—discussed share repurchases. Companies trading at the greatest discount to net asset value, including regional mall, office, and shopping center REITs, were most likely to institute repurchase programs.
As long as the current situation persists—a (sometimes steep) misalignment between net asset values and REIT share prices—management will work to boost share prices and investors will look to opportunistically benefit from the perceived mispricing. It is too soon to predict whether this wave of privatizations will be as large as the one that occurred between 2005 and 2007, when more than 30 U.S. REITs were acquired, but additional privatizations are expected, and further share buyback programs will likely be announced.
* 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 10/23/2015.
