Institutional investors find opportunitiesto diversify their portfolios.
lthough capital continues to flow into commercial
real estate at unprecedented levels, the real news is the intense competition
for properties as well as the size, diversity, and complexity of transactions
this money fuels. U.S. real estate investment trusts and REIT-like structures
worldwide are taking advantage of this highly charged environment to diversify
and grow their portfolios. How long will this climate continue? Analyzing
recent transaction activity may offer clues about the future of instit
commercial property investment.
The Market's Evolution
In 2004, the big stories were 27 REIT initial public offerings totaling
more than $7 billion and 20 public REIT mergers and acquisitions involving $34
billion, most notably some very large transactions
in the retail sector. In
2005, the big news was real estate private equity funds buying public REITs and
What is the big story this year? Although public REIT
merger-and-acquisition and IPO activity declined slightly during 2005 from the
record-breaking 2004 levels, activity so far
this year indicates that both
trends show healthy signs of increasing. Transaction numbers and the volume of
recent significant merger-and-acquisition activity are up with respect to
private equity funds buying public REITs.
Private equity investor Blackstone Group has acquired more than $20 billion in hotel assets, including the La Quinta hotel chain for $2.3 billion in April.
photo credit: LQ Management LLC
Pension funds remain the single
largest source of capital fueling institutional private equity funds' ongoing
acquisitions. These pension funds, in search of yields that will generate the
income needed to meet their rising obligations, remain committed to real estate
as an asset class for a number of reasons. For instance, changing baby boom
demographics and the associated need for increasingly higher yields on
investments; the real estate market's past performance across all property
types; real estate's worldwide appeal due to available information and
research; and greater investor confidence, scrutiny, and increased transparency
in financial reporting are key
reasons pension funds continue to seek real
estate. In addition, commercial real estate can provide consistent cash flows
and portfolio diversification.
Projected new capital flows into real estate from all tax-exempt
investors will total $59.3 billion this year, according to an Institutional
Real Estate survey, an increase of about 16 percent over 2005's figure. Of that
capital, 26.7 percent is allocated to opportunistic investments, 26.2 percent
to value-added strategies, and 21.8 percent to core real estate.
While pension funds historically have allocated some 4 percent of their
total assets to real estate, many experts believe that this percentage may rise
to 10 percent to 15 percent of total assets within the next decade. This
monumental shift in asset allocations could well mean future annual commitments
to real estate in excess of $100 billion.
Many large pension funds have sold investments to lock in higher returns
and reposition their portfolios. For example, the California Public Employees
Retirement Systems, or CalPERS, reported a 40.8 percent return on real estate
investments during the year ending June 30, 2005, making it the best year in
the fund's history - a result of property sales driven by unprecedented market
pricing levels. Returns such as these clearly provide the impetus for many
other pension funds to increase their allocations to real estate.
In addition to pension funds, tax-exempt endowments, high-net-worth
individuals, and foreign investors continue to pour substantial capital into
private equity funds. An
estimated $118 billion is available this year for
value-added and opportunistic real estate investments worldwide, according to a
recent Ernst & Young survey.
REIT Privatization Increases
tional real estate private equity funds offer a wide and
varied menu such as core and value-added funds, real estate hedge funds,
opportunistic funds, and mezzanine debt funds, among others. Real estate funds
not only are making direct investments in properties, they now are investing in
public companies including REITs.
Because of the fierce competition
to acquire properties and the record-high pricing found across most asset
classes, private equity funds have amassed billions of dollars and are
searching for larger targets where the rarified atmosphere limits competition.
Consequently, REITs have become attractive takeover candidates primarily
because these funds believe an arbitrage exists between the value of a REIT's
assets and its stock price.
REIT privatization reached unprecedented levels in 2005 and many
industry experts believe that as many as 10 REITs may privatize this year.
Generally speaking, REITs privatize for a few key reasons such as the disparity
between the REIT share price and the underlying assets of the REIT, the high
cost of Sarbanes-Oxley compliance, a propitious time to sell in a current
climate of high demand and record low capitalization rates, and increased
flexibility of operating as a private company.
From early 2005 through June 15 of this year, approximately 12 public
REITs were acquired and taken private. A recent transaction that surprised many
industry experts is Brookfield Properties and the Blackstone Group's
joint-venture acquisition of Trizec Properties for $8.9 billion in equity and
assumed debt. This sale was the second-largest REIT merger and acquisition
transaction ever recorded, following only General Growth Properties' 2004
acquisition of the Rouse Co. for approximately $12.6 billion including equity
and the assumption of debt.
This transaction comes on the heels of the Blackstone Group's previously
announced $5.6 billion pending acquisition of office REIT CarrAmerica Realty -
a transaction that dwarfed the largest announced REIT acquisition of 2005,
Arden Realty's sale to GE Real Estate for $4.8 billion. In fact, last year
eight publicly traded REITs were sold or announced involving more than $20
billion, as compared with 2004 when only three REITs went private for a total
cost of $2.6 billion.
Private equity activity indeed spans the gamut of all commercial real
estate property types. (See table.) In addition to the property type
transactions illustrated, significant merger-and-acquisition activity in the
hotel sector includes the following deals.
In the past two years, the Blackstone Group has gobbled up more than $20
billion worth of hotel companies including its most recent announced purchase
of MeriStar Hospitality for $2.6 billion. Recent purchases also include Wyndham
International for $1.44 billion, La Quinta for $2.3 billion, and Extended Stay
America for $2.0 billion.
Colony Capital, along with Kingdom Hotels International, recently
purchased Fairmont Hotels for $3.3 billion. In addition, they acquired the
Raffles Hotels & Resorts luxury chain in 2005.
Starwood Capital Group recently acquired the Paris-based luxury hotel
chain Groupe Taittinger.
Many experts predict that this steady stream of REIT privatizations is
likely to continue - a trend being fueled by two separate factors on the buy
side. In certain cases, many value-added and opportunistic funds are looking to
take advantage of REITs' development pipelines and are willing to pay premium
prices to gain control of their real estate assets. Secondly, many investors
are eager to acquire a group of properties in a single, large transaction. At
the same time, some REIT managers
consider privatization because it eliminates the pressure to accommodate
the demands of shareholders.
Although the trend toward private equity funds acquiring public REITs
continues, some companies are moving in the other direction by forming their
own private equity funds that potentially could go public at a later date. This
strategy identifies public markets as a possible exit route for privately held
real estate companies - a strategy that might emerge from the big REIT acqui
of 2005 and 2006, particularly if market conditions change.
Given the density of available institutional capital, a number of public
REITs recently have created private equity funds as a way to access the flow of
capital into real estate. For example, two large industrial REITs, ProLogis and
AMB Property Corp., recently launched their own private equity funds. In 2005,
AMB successfully started a $2.2 billion fund focused in Japan with
institutional investors providing approximately 80 percent of the fund's total
equity. In March, ProLogis launched the ProLogis North American Industrial
Fund, an open-end fund that raised $1.85 billion from a global institutional
investor base. If current market conditions continue, look for many other REITs
quickly to follow suit and create their own private equity funds as vehicles to
further access institutional money.
The public REIT vehicle is becoming a more widely utilized structure for
institutional private real estate investors and could potentially become an
exit strategy for many private REITs. For instance, Kohlberg Kravis Roberts
recently raised $839 million in a REIT IPO. J.E. Roberts, a real estate
advisory firm and opportunistic investor, also recently created a publicly
traded REIT called JER Investors. This trend is likely to continue as market
conditions change and companies seek liquidity by way of public markets. Many
private REITs invariably will need to examine this strategy to provide
liquidity for their investors as well.
Last year Colony Capital and Kingdom Hotels International purchased Raffles Hotels & Resorts, which includes luxury properties such as the Raffles L'Ermitage in Beverly Hills, Calif.
photo credit: Raffles Hotels & Resorts
At the end of 2005, slightly fewer than 200 U.S. REITs existed and REITs
and REIT-like entities began appearing in Europe and Asia. However, REIT-like
legislation enacted worldwide has provided new opportunities for property
owners to obtain liquidity, access new sources of capital and potentially
provide tax benefits to owners and investors. Given this continued trend toward
greater foreign REIT-like legislation, U.S. REITs are likely to increase their
overseas merger-and-acquisition activity as well as their capital commitments
to real estate projects throughout the world. Additionally, this REIT-like
legislation will continue to provide access to global real estate markets to
individual high-net-worth investors seeking an alternative to the current
competitive nature of the U.S. real estate market.
Some 20 countries including Australia, Belgium, Brazil, Canada, France,
Greece, the Netherlands, China (Hong Kong), Italy, Japan, Singapore, Mexico,
Spain, and Turkey recently have passed their own legislation creating REIT-like
structures. Australia and the Netherlands currently have the most established
REIT markets. Germany recently announced plans for its own REIT market and
similar legislation also is pending in the United Kingdom.
As the year winds down, the industry can expect more sophisticated and
complex transactions of larger magnitude to continue as entities take advantage
of abundant capital and increasing worldwide opportunities. The emerging
industry developments are likely to continue on a global basis as the number of
potential acquisition candidates grows, capital remains plentiful, and market
fundamentals continue to improve.