Conference Panel Agrees That Partnerships Between Public and Private Market Players Are Hallmark of Current Market
A panel of private-equity CEOs at this week's Citi Global CEO Conference in Hollywood, FL, agreed that partnerships between public and private players are vital to a healthy and dynamic real estate market, and expect to see more private equity investors step up their game as active buyers as REITs dispose of non-core assets.
"The REIT market is here to stay and the real opportunities for guys like us are from time to time to partner with the REITs to help solve problems, expand a brand, expand a franchise, or go global," said Ralph Rosenberg, global head of real estate for global investment firm KKR & Co. and a former hedge fund manager and Goldman Sachs trader.
When Blackstone buys a business such as Hilton, Equity Office Properties or Extended Stay America, or builds a new platform such as it has in industrial or retail, the company never knows its exit strategy exactly. Therefore, Blackstone prefers an attractive equity market since the acquired company may be sold whole or in parts, merged into an existing public entity, or taken public as a new company, noted Blackstone Senior Managing Director A.J. Agarwal.
Colony Financial Inc. employs a strategy that contains both of those themes.
"We view the public markets as integral to how we think about strategy, and how we want to capitalize various businesses we’re investing in," said Richard Saltzman, Colony Financial president. "While Blackstone and KKR are public companies, we’ve chosen to keep our holding company private, and we’d like to keep it that way for the foreseeable future."
That said, Colony is incubating single-family rental businesses that are interesting with high growth potential -- "maybe starting them privately, but with an aim toward trying to take them public, because we think they’re perpetual-life businesses that are arguably better capitalized long term as public companies."
Blackstone's Agarwal agreed that private and public companies dwell in the same ecosystem.
"When we sell assets that are stabilized, often times the buyer of those assets is a REIT. When we buy assets, often times they may be lower-growth, non-coastal, non-Top-20 market assets," he said. While REITs want leverage in the 30% range, "we’re obviously prepared to bear leverage from 2/3 to the low 70%s in our acquisitions."
Assets that may not be attractive in the public market because they won’t drive FFO growth or aren't attractive to Wall Street may work out to be very attractive investments for private owners like Blackstone, Agarwal said.
Despite forecasts for moderating returns on core real estate during the next five years compared with recent performance, private real estate still ranks as an attractive asset class, according to the U.S. Real Estate Strategic Outlook by RREEF Real Estate 'released last week. The five-year forecast calls for 7.6% returns for private companies, essentially unchanged from last fall.
Meanwhile, the cost of capital advantage enjoyed by REITs and improving property fundamentals should enable investment trusts to continue to generate low double-digit returns during the coming year, RREEF said.
"This positive momentum in the public markets bodes well for private markets, which typically lag REITs by three to four quarters," the RREEF report said.
"Returns in the private markets are likely to see a rise during the next year based on recent REIT trends."
Additionally, new REITs entering the market in the past year and more expected in 2013 should bring more capital into the sector.
"Increased capital typically translates into further price increases and this should support higher capital appreciation in 2013 on the private side," RREEF said.
Returns to unlevered real estate will likely moderate, producing an average of 7.6% during the next five years. Compared with 10-year Treasury yields in the 2% range, private real estate is poised to provide an attractive total return risk premium in the range of 5.6%, compared with its historical level in the range of 3%, RREEF said.
The REIT sector returned 19.7% in 2012, according to the NAREIT All Equity Index, the fourth consecutive year in which REITs outperformed the S&P 500. That compared with 10.9% for the private real estate market as measured by the NCREIF Fund Index/Open End Diversified Core Equity (NFI-ODCE).
RREEF attributed at least some of last year's REIT outperformance to higher leverage available for the public sector. However, while REITs traded at a premium to their net asset values (NAV) early in 2012, the spread narrowed and turned to a slight discount in the fourth quarter.
Real estate securities continue to have a favorable cost of capital compared to private real estate investors, with unsecured debt and perpetual preferred equity yields at all-time lows, and REITs are using this competitive advantage to acquire and, recently, to develop assets at accretive spreads, RREEF said.
In the low interest rate environment following the financial crisis, the demand for REIT stocks due to their ability to deliver steady income and capital appreciation.
REIT stocks outperformed the broader equity market in 2012 for the fourth straight year with a relatively strong first half of the year followed by a modest second half, although returns slipped a bit in January.
Consistent, solid dividend yields have made REITs more attractive to investors over the long term. From 2007 to 2009 following the financial crisis, REITs took considerably less leverage than private real estate investors.
Many REITs were able to sell at the top of the market when private equity investors were still buying. Then, during the downturn when access to capital was limited, REITs were able to acquire high-end properties from highly leveraged investors at deep discounts.
As institutional investors allocated their dry powder to REITs, the trusts were able to raise capital to pay off debt during the credit crunch. Trusts were able to raise a huge sum of public equity and debt capital in the volatile markets of 2011 and even more in 2012 through secondary equity, common and preferred share offerings, unsecured debt and IPOs.
Moreover, equity REITs lowered their debt ratio from 51% during the financial crisis to just fewer than 34% in third quarter 2012, according to NAREIT.
Most analysts believe low interest rates will allow REITs, particularly those with solid balance sheets and access to capital, to capitalize on M&A opportunities, noting how transaction activity picked up in the latter part of 2012.