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Timing of Monogram Residential sale talk raises eyebrows, analysts say

MonogramResidential Trust Inc. may be an attractive takeout target becauseof its relatively young portfolio of centrally located apartment buildings, butthe timing of sale rumors surrounding the company is surprising, analysts said.

Monogram — which in the past year has with an activist investor,overhauled corporategovernance procedures and sparred with representatives of its former externalmanager (two of whom still hold seats on the company's board) — is nowweighing a sale, andhas "sounded out potential buyers," according to a Sept. 26 report inThe Wall Street Journal.

The company did not respond to a request for comment.

In notes and interviews, analysts said Monogram's portfoliocould be appealing to a range of potential buyers, including public REITs orprivate investors. Its properties are far newer on average than its publicmultifamily peers' and tend to be located in desirablecentral-business-district locations, both on the coasts and in the Sun Belt.

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Monogram's properties offer a good fit with the portfoliosof Apartment Investment andManagement Co., UDRInc. and CamdenProperty Trust, BMO Capital Markets analyst John Kim said in anote, adding that the larger bicoastal REITs, Equity Residential and AvalonBay Communities Inc., would likely be interestedonly in some of the company's assets.

The portfolio may be a better fit for a private buyer, givenMonogram's relatively high leverage levels, Robert W. Baird analyst Drew Babinsaid in an interview. The company's leverage on current EBITDA, annualized, is"very high," in the 11x range, Babin said. Though leverage will comedown once the company's development pipeline stabilizes, a private buyer may bemore willing to take on debt than a public REIT, he added.

Even amid growing worries about several key multifamily markets, the fieldof potential private acquirers may be wide open, especially given Monogram'srelatively small size, which Babin said would make it easily digestible.

BlackstoneGroup LP, BrookfieldAsset Management Inc.and Starwood Capital Group have all made high-profilemultifamily acquisitions in recent years, and Monogram has joint ventures withthe Dutch pension fund PGGM and the National Pension Fund of the Republic ofKorea Government.

"In the private equity world right now, you can get a10-year fixed-rate mortgage, GSE-backed, at 3%, 3.25%," Babin said."Debt is so widely available and cheap that even with fundamentalsdecelerating, there's a very attractive cost of capital out there for anybodylooking to buy."

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Monogram may be exploring a sale now in part to takeadvantage of the favorable conditions for buyers — especially those, likeprivate equity firms and sovereign wealth funds, that have investment horizonslong enough to ride out an economic downturn, Babin said.

Still, both Babin and Canaccord Genuity analyst Ryan Melikercalled the timing of the sale rumors surprising, because of several unresolvedmatters clouding the company's near future.

"They've got a massive level of development, and youtypically don't want to sell until your developments are complete, you'veexecuted, you've created value, you've stabilized the cash flows," Melikersaid. "Then you sell the company. Because otherwise, you're passing on thedevelopment risk to a buyer, who's going to discount your portfolio because ofthat risk."

Potentially thornier is a fee that Monogram could owe toBehringer Investments, which controls its former external manager and still hastwo seats on the REIT's board.

In short, Behringer owns 10,000 units of convertiblepreferred securities that entitle it to an incentive fee if the company's shareprice reaches a certain level — believed to be in the $11.60 to $11.70 range —during a certain period.

The length of the measurement period is in dispute: Thecompany contends that it ends in February 2017 but Behringer says it is roughlysix months longer. But the upshot is that the former manager and itsrepresentatives would benefit significantly from a company sale, soon, at aprice in the $12-per-share range or higher. Behringer's board seats are alsoexpected to change hands in mid-2017, meaning the former manager will soon losea measure of influence over the REIT's future.

By contrast, Meliker said, a sale in the near term wouldpotentially shortchange shareholders not affiliated with Behringer, bydiverting a large portion of any acquisition money into the former manager'shands.

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Given the inventive fee and the development uncertainty,Meliker said the Monogram board would likely prefer to wait for a sale. Theboard has ample real estate experience: It includes REIT-space veterans such asTimothy Pire, formerly a portfolio manager at Heitman, and W. BenjaminMoreland, formerly president and CEO of Crown Castle International Corp., plus nonvoting R. Scot Sellers, theformer CEO of Archstone.

The question, then, is why the sale discussion is happeningnow.

If the company is truly sounding out buyers, "my bestguess is they probably received an unsolicited offer for the company,"Meliker said. If that is what happened, he added, "the board is goingthrough the appropriate process and doing their due diligence before theyaccept or reject the offer."

Or, as Babin theorized, board members may simply want toexplore a sale before an uncertain multifamily environment takes a turn for theworse. Even given concerns about the real estate cycle, he said, a buyer may bewilling to pay a per-share price above $12 for the company, for a capitalizationrate in the 4.5% range, a far better valuation than the company's stock pricecurrently implies.

"I think Monogram knows they face a lot of supply inthe near term, and that they're going to face a lot of deceleration in theirmarkets," he said. "They know that they're below NAV, and it's hardfor them to develop more and acquire more, given what their share price isrelative to NAV. They know that they need to get leverage down, and there's nota whole lot of options, other than dilutively selling properties to do that. Sothey're in a bit of a box."

In light of all those factors, a sale may be the best option.

"I think in this environment, where fundamentals areclearly decelerating, it's hard to get credit for the intrinsic value of yourreal estate," Babin said. "The only way you probably get full creditfor what you own, and you trade at NAV, is somebody buys you."