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With so many REITs trading at discounts, where is the M&A?

Someprominent voices in REITland are saying a new round of M&A in the space is not only desirable, but ought tohappen out of necessity, via either public-to-public deals or a round of privatizations.

Realestate mogul Sam Zell has for a long time been a proponent of REIT M&A, believinga small group of large and liquid REITs to be the ultimate end game of the industry'sgrowth and maturation.

"Youknow, there just isn't any substitute for scale," Zell said April 13 at NewYork University's annual REIT Symposium. He predicted REITs will grow steadily insize over the next couple of years on another wave of M&A, though many smallcompanies may linger on for reasons of "ego."

Duringa Q&A early in the conference, Zell lamented the plethora of REIT "orphans"on the scene — small companies without the requisite size and liquidity to be effectivein the space.

"You'vegot $1.5 billion office REITs. What are you doing? How do you create liquidity?How do you go forward? How do you raise more capital? I think those are all challengesvery much related to size," Zell said. "And if I were an institutionalinvestor, I can't imagine investing in these little companies."

M&Awas the focus of the conference's opening panel, and its moderator brought the matterfirst to panelist Mike Kirby, chairman and director of research at Green StreetAdvisors, who has long been a critic of public-to-public REIT M&A but who nowprofesses to be at least agnostic on the issue.

Citingroughly 25 years of data, Kirby said public-to-public deals have tended to be goodfor the company being acquired — which typically receives a sizeable premium ina deal — but to accomplish little beyond modest synergies for the company doingthe acquiring.

"It'snot something we get terribly excited about one way or the other," he said."We're not anti-M&A as a growth strategy. We're not pro-M&A as a growthstrategy."

Later,however, Kirby said the current NAV discounts among REITs present clear arbitrageopportunities.

"Asa general rule, I think it's really smart for companies that are blessed with theNAV premiums to grow aggressively, because as long as you own a group of assetsthat look a lot like the assets that are out there in the marketplace that you mightbuy, I would argue there's an arbitrage opportunity," he said.

The handful of REITexecutives quizzed on M&A at the conference offered nuanced perspectives onprospective deal flow, and their remarks indicated a measure of caution is at play.

Prologis Inc.Chairman and CEO Hamid Moghadam warned of the difficulties inherent in integratingtwo distinct company cultures. And asked why, with its significant NAV premium,Public Storage had notbeen pursuing deals, Chairman, President and CEO Ronald Havner Jr. turned the conversationto cash-flow multiples.

"On a cash-flow basis, there's not an arbitrage. … At theend of the day, for us, it's really all about cash flow. And can we do transactionsthat improve the long-term growth rate of our cash flow? It's not as simple as [trading]at a premium and someone else is selling at a discount," he said.

Havner said excessive fees associated with deals have also servedas a deterrent.

Most executives agreed, however, that a sizeable discount wouldhave to be at play in any public-to-public deals today. In an interview, CEO Jim Connor explainedthat the lack of public-to-public M&A activity in the industrial space is aproduct of broader market volatility.

"We'd all like to be bigger, but being bigger is not theend-all," Connor said. "You can't overpay and do a stupid deal just forthe privilege of getting bigger."

Connor added that even a significant discount to NAV is not sufficientrationale for a deal. Even if there are undervalued industrial REITs, their publiccounterparts could remain on the sidelines if they feel their own shares are nottrading at fair values, the executive said.

"They think their whole company should trade based on thevalue of the lowest cap rate they've heard in the last two years," Connor said."And it's even harder if you [look at] the private side, because the privateguys are flipping a great coupon, they're making money, they're making deals."

The public-private pricing divide indeed may prove to be a morevital area of deal flow. In a conference-opening address, Adam Emmerich of Wachtell LiptonRosen & Katz predicted privatizations will become an even more prominent featureof REIT M&A this year, though perhaps not at the level seen in the period from2005 to 2007, when $140 billion in enterprise value crossed the public-private divide.

"Weexpect dealmakers to be more circumspect, but low interest rates, large amountsof private capital seeking deals, including sovereign capital, and public-to-privatearbitrage opportunities will continue to fuel take-private transactions," hesaid.