Industry Titans, Analysts Say Apartment REITs Are A Target-Rich Environment For Private Equity, But Deals Won't Be Easy
The proposed $22 billion leveraged buyout of Archstone Smith (NYSE:
ASN) by Tishman Speyer and Lehman Brothers may spark a new round of go-private deals in the apartment REIT sector.
Rumors about new takedowns have driven up shares of almost all multifamily REITs after several lackluster months in the REIT space following Blackstone’s $39 billion buyout of Equity Office Properties Trust. More deals seem likely among multifamily REITs, largely due to the fact that as a group they are trading at an average 6% discount to net asset value in a strong apartment market.
That's not to say any future deals won't be painful and complication-free, however, as sellers and buyers continue to puzzle over the disconnect between the value of public REIT shares and their perceived worth on the private market.
"Everything we hear -- and obviously the Archstone deal reaffirms that -- is that private valuations are holding up and fundamentals remain good," said Alexander Goldfarb, REIT analyst for USB Securities LLC. "The private money is still there. We estimate there’s $1.5 trillion in capital that still wants to go in real estate. It’s patient and will wait for the right opportunities."
REIT prices have generally weakened after years of beating the stock market, with Morgan Stanley’s U.S. REIT index down 2% year to date and 15% since the EOP/Blackstone deal shocked the real estate and investment world in February. But the proposed Archstone buyout unleashed a fresh wave of market euphoria at REITWeek, last week’s industry confab by the National Association of Real Estate Investment Trusts (NAREIT).
The buzz continued this week as shares of Archstone rival AvalonBay Communities Inc. (NYSE:
AVB) rose sharply Wednesday on rumors of a buyout by -- who else? --Blackstone. The 6.7% jump was the day's steepest advance in the S&P 500. Both companies declined comment. Until last week’s NAREIT conference, analysts speculated whether AVB might top Tishman’s $60.75-a-share bid for Archstone, a highly regarded REIT which had previously traded at a 15% discount to its NAV.
"M&A is a topic that’s on everyone’s mind," Goldfarb said. "The talk isn’t just in the halls at the NAREIT and ICSC conferences, it’s in the investor meetings with company management."
There are other signs Wall Street is cozying back up to the sector. Shares of Post Properties Inc. (NYSE:
PPS) jumped last week after a report said its founder submitted an all-cash bid for the company, topping a prior offer by another suitor. Industry watchers have cited Home Properties (NYSE:
HME), Equity Residential (NYSE:
EQR) and Camden Property Trust (NYSE:
CPT) as possible takedown targets in recent days.
At REITWeek, the troika of EOP dealmaker Sam Zell, Vornado Realty (NYSE:
VNO) chief Steven Roth and GE Real Estate President/CEO Michael Pralle all agreed that the Archstone deal probably isn’t the top of the market. When those industry icons speak, investors tend to listen.
Of course, the deal for Englewood, CO-based Archstone, one of the largest multifamily REITs with about 86,000 units worldwide, has its skeptics. The financial newspaper Barron’s opined in its June 11 issue that the deal is a "gigantic gamble" because Tishman Speyer and its partners will pay more than $1 billion in interest -- more than ASN’s $800 million projected NOI for 2007 -- on the $17 billion borrowed for the deal. That means the Tishman group will likely have to dispose of as much as $8 billion of the REIT's multifamily assets in Manhattan, New Jersey and San Diego at the deal's 4.3% cap rate to cover the expense.
Analysts say even if apartment fundamentals remain strong, all bets are off if interest rates don’t fall and capital dries up. Any topping offer for Archstone would have to be at least $4 per share more than the current bid to hedge risk and to overcome the agreement’s $235 million breakup fee.
Fueled by the topping rumors, ASN’s shares have traded at or above the Tishman bid price since the deal was announced late last month. The offer represents a nearly 23% premium over the pre-deal stock price.
Another Archstone bid could come in if interest rates fall and CMBS spreads narrow, making debt markets more attractive, Citigroup’s Craig Melcher said in a note to investors. There’s plenty of time for another offer before this summer’s deal closing, Melcher said, noting that Vornado made its unsuccessful play for EOP two months after Blackstone’s initial bid.
However, with 10-year Treasury rates rising, anyone using leverage to buy at a sub-5 cap rate is going to have to look carefully at the value and growth potential of portfolios and proceed with caution, said Bob Hart, president/CEO, Kennedy Wilson Multifamily Management Group Ltd.
.
"There is a limit to what private equity will pay. They still need double digit or better returns," Hart said.
One key difference between the EOP/Blackstone and Archstone/Tishman transactions underscores the continuing strength of the commercial real estate market, Goldfarb said. Sam Zell sold EOP outright and walked away, while Archstone management plans to stay on board after the deal closes. In fact, CEO and Chairman R. Scot Sellers is personally investing $8 million in the transaction.
"They could have walked away and received the change-of-control check and retired on some beach, but instead they’re going to stay in it," Goldfarb said.
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