The positive sentiment that has propelled the stock market to record highs in 2017 has failed to coax many new real estate investment trusts to the public market.
Some real estate industry observers had thought the breakout of real estate from financials in the influential Global Industry Classification Standard, or GICS, in 2016, and the subsequent arrival of new investors to the space, could yield more REIT IPOs. Indeed, when Blackstone Group LP's single-family rental unit Invitation Homes Inc. came to market at the beginning of the year and raised a staggering $1.77 billion, it seemed that IPO momentum was building in the space.
But 2017's REIT IPO count has fallen short of expectations, and deal flow is not likely pick up in the fourth quarter, industry experts said. Josef Schuster of the research firm IPOX said the overall IPO market — which he noted has been active in general in 2017 across industries, with solid average initial returns — tends to slow toward the end of the year. The deals shrink in size, and they become less frequent.
"We have really good momentum in the IPO market overall," he said. "But ... REITs are always something kind of different."
In an interview, Schuster said the retail REITs' struggle against negative investor sentiment, after a withering round of post-holiday season retailer bankruptcies, has sapped investors' appetite for risk, as has the ongoing possibility of rising interest rates. REITs tend to underperform when rates are on the rise.
For some institutional investors, lingering risks in the REIT space right now may be too significant to take on more in an IPO, even if fundamentals in many subsectors remain strong, Schuster said.
Daniel Adams, partner at the law firm Goodwin Procter, attributed the fall-off in REIT IPOs in part to the relative appeal of private market valuations, which have made the already arduous, and expensive, task of preparing to go public even less of a draw.
"There may be less of a desire for certain private operators to go public because they're able to easily attract plenty of capital in the private market," he said. "And to the extent that they're looking to exit, there are a lot of big players out there with plenty of capital to take down even large portfolios, and they can exit at attractive valuations."
Adams said the coming months may yield more privatizations of public portfolios if the public-private pricing divide endures. In the meantime, the big public REITs are likely to continue selling joint-venture interests in their marquee properties to capitalize on the pricing disconnect — a route Adams himself deemed "very attractive" for the public companies.
David Bonser, head of Hogan Lovells' equity and U.S. debt capital markets practice group, said that while appetite for smaller IPOs has been healthy in other sectors, it has diminished in the real estate space. The high costs associated with being a public company do not pencil for many smaller-scale real estate concerns, and the lower trading volume makes it difficult for investors to exit their investment.
Bonser also pointed to high private market valuations as a drag on IPO deal flow. Compounding that issue, he added, is the fact that dedicated REIT investors, the so-called REIT mafia, still demand significant discounts to go in on an offering. And while the GICS change has brought in new investors and driven up the price for individual assets, it has not brought in many who are willing to buy big blocks of shares in an IPO.
"If you want a large institutional book for your IPO, which you know you need for success, there still aren't as many large buyers of real estate as there have been in other spaces, really," he said.