2007 was a big year for REIT privatizations, until the credit crunch hit. What’s next for M&A in the REIT industry?

By Dees Stribling

Until late summer of 2007, the pace of mergers and acquisitions in the REIT industry was on track to match the frenetic activity of 2006. As of mid-September, there had been 17 completed REIT M&A deals during 2007, totaling approximately $70.7 billion, according to SNL Financial. That figure includes equity value plus any debt and preferred securities assumed in the transaction. Fourteen of the total were privatizations.

		No Two REIT Privatizations Are Alike In the REIT industry, the 2000s might be called the decade of privatization—at least until the credit crunch this past summer. Yet not all privatizations are of the same mold.

By mid-2007, the subprime contagion was on its way. Despite the clear difference between problems in residential mortgage lending and the general good health of the equity REIT business, the credit crunch put the brakes on M&A and privatization for the rest of the year, says Lou Taylor, senior real estate analyst with Deutsche Bank. In fact, because most private equity deals are funded largely with debt, the credit crunch put a number of announced deals in doubt.

"There's no question that there's been a slowdown of activity," Taylor says. "The credit crunch is affecting M&A deals in all industries, and REITs are no exception."

Total M&A activity for all of 2006 was approximately $106 billion in 23 REIT deals, 11 of which were privatizations. Of course, the 2007 total through mid-September includes the behemoth $39 billion privatization of Equity Office Properties Trust by The Blackstone Group, which greatly boosted the total.

Then again, 2006 had some fairly large deals of its own to drive up the year-end total, most notably the $9 billion Brookfield Properties Corporation (NYSE: BPO) and Blackstone acquisition of Trizec Properties.

Hitting the Brakes

One of the driving forces behind the REIT M&A and privatization flurry of the 2000s, up to and including 2006 and 2007, has been access to cheap capital, notes Paul Adornato, senior research analyst for BMO Capital Markets. "However, that tap has been shut off for the time being," he says.

Not only that, the market for real estate-related debt has dried up. "Investors are no longer willing to buy highly leveraged mezzanine loans and equity pieces," Taylor says. "The debt landscape has changed."

This state of affairs won't last forever, but it will have a lingering impact, Adornato says. "Once the credit crunch eases, the cost of capital will have been re-priced upward, so the kinds of deals we've seen recently aren't going to be as frequent," he says. "Opportunistic buyers are on hold for now."

That isn't to say that M&A or privatization activity is dead. "Once the volatility of the capital markets settles down, there will probably be renewed interest in some deals," says Keven Lindemann, director of SNL Real Estate. "Access to cheap capital might go away, but valuations of the underlying real estate haven't changed. Investors will still be interested in REITs because of the undervaluation of real estate in the public markets relative to that in the private markets."

REITs still inspired such investor interest well into the summer of 2007, even in the face of uncertain financial markets. In fact, platform building, either privatization or REIT-on-REIT activity, might be a renewing factor for M&A activity, Lindemann says. "In recent years, especially in 2007, privatizations eclipsed public-to-public REIT deals to some degree, because private equity investors could compete more effectively on the basis of their cost of capital," he says. "That seems to be over. Future acquisitions will likely be more strategy-driven than financing driven, in that the buyer will look for some synergies between its existing portfolio and the new one."

2007 REIT Merger and Acquisition Activity
Acquiror	Target	Acquiror Type	Transaction Value (in millions)	Date Announced	Completed Date
Ventas, Inc.	Sunrise Senior Living REIT	Public REIT	$1,036	1/14/07	4/26/07
Simon Propery Group; Farallon Capital Management	Mills Corporation	Public REIT; Investment Advisor	$1,350	1/17/07	4/3/07
Morgan Stanley	CNL Hotels & Resorts Inc.	Brokerage Firm	$6,702	1/19/07	4/12/07
Brookfield Asset Management Inc.	Longview Fibre	Asset Management Firm	$2,150	2/5/07	4/20/07
Blackstone Group	Equity Office Properties Trust	Private Equity Firm	$39,000	2/7/07	2/9/07
Credit-Based Asset Servicing and Securitization LLC (C-BASS)	Fieldstone Investment Corporation	Mortgage Banking Firm	$259	2/16/07	7/17/07
Centro Properties Group	New Plan Excel Realty Trust, Inc.	Australian LPT	$6,200	2/27/07	4/20/07
Macquarie Bank Limited, Kaupthing Bank hf, et al.	Spirit Finance Corporation	Investment Advisor/Brokerage Firm	$3,500	3/13/07	8/1/07
Inland American Real Estate Trust Inc.	Winston Hotels, Inc.	Non-traded REIT	$460	4/3/07	7/2/07
Apollo Investment Corporation	Innkeepers USA Trust	Closed-End Investment Company	$1,500	4/16/07	6/29/07
JER Partners	Highland Hospitality	Private Equity Firm	$2,000	4/24/07	7/28/07
AP AIMCAP Holdings LLC	Eagle Hospitality Properties Trust, Inc.	Closed-End Investment Company	$319	4/27/07
Morgan Stanley	Crescent Real Estate Equity	Brokerage Firm	$6,500	5/23/07	8/3/07
Tishman Speyer/Lehman Brothers	Archstone-Smith	Real Estate Company/ Brokerage Firm	$22,200	5/29/07	10/5/07
Whitehall Street Global Real Estate, LP	Equity Inns, Inc.	Investment Advisor/Brokerage Firm	$2,200	6/21/07	Pending
Sentinel Omaha LLC	America First Apartment Investors	Real Estate Advisory Firm	$532	6/25/07	Pending
Liberty Property Trust	Republic Property Trust	Public REIT	$850	7/24/07	10/4/07
Behringer Harvard REIT Inc.	IPC U.S. REIT	Non-traded REIT	$1,400	8/14/07	Pending
Total Transaction Value			$96,757
Total Public to Public Transaction Value			$9,436
Total Public to Private Transaction Value			$87,321

Defining Deals

If this year is remembered for nothing else, it will be for The Blackstone Group's acquisition of Equity Office Properties Trust. At $23.2 billion, along with the assumption of roughly $16 billion of debt held by Equity Office, it was not only the biggest REIT M&A of the year, it was the biggest real estate transaction ever, unless one counts some incomparable deals such as the Louisiana Purchase. In play was a portfolio of 543 office properties amassed over the years of one of the companies chaired by Sam Zell, totaling 103.1 million square feet nationwide.

Moreover, there was drama. The deal was inked in December 2006, but it wasn't long before a rival bidder emerged. Vornado Realty Trust (NYSE: VNO), leading a group that also included Starwood Capital and Walton Street Capital, made a $52 per share cash-and-stock counteroffer to Blackstone's initial offer of $48.50 per share. By early February, both bidders had upped the ante, with Blackstone eventually offering $55.50 per share all-cash, while Vornado's group had a $56 per share cash-and-stock offer on the table.

"The Blackstone-Equity Office transaction was a prime example of 2007's private equity being in a strong competitive position for acquisitions relative to public REITs," Lindemann says. "Vornado has to answer to its stockholders, and however much it might have wanted the Equity portfolio—and Vornado wanted it badly—in the end, it couldn't justify an even higher bid than already had been made."

The other giant privatization of the year involved apartment behemoth Archstone-Smith Trust (NYSE: ASN), which at approximately $22 billion is a little less than two-thirds the size of the Equity Office deal. The buyer in this case was Tishman Speyer, which partnered in a joint venture with Lehman Brothers Holding, Inc.

Like the Equity Office deal, this merger offered the REIT industry a measure of drama, though not the specter of dueling bidders. Instead, the credit crunch hit before the deal closed, which gave rise to speculation that funding necessary to complete the transaction might dry up. There was also the prospect of lawsuits by shareholders seeking to block the privatization.

In the end, the funding came through as planned, and the stockholders were placated. "I see the Archstone-Smith deal as more of a long-term play on the part of Tishman Speyer,"

Adornato says, contrasting it with the buy-and-flip plans that Blackstone had for many of Equity Office's assets. "Archstone-Smith is a good company that would simply prefer to be private."

The Next Step

With the deal frenzy having slowed, how will REIT M&A activity continue to play out into 2008? Considering the turbulence of the financial markets in 2007, that isn't clear yet, Lindemann says.

"Right now, no one is sure how long the financial markets will have the jitters," he says. "However, there is a possibility that M&A activity will return by early 2008. But it's not likely to be like 2005 or 2006, when activity was through the roof."

BMO's Adornato points out that the size of the publicly traded REIT universe is eventually going to be a limiting factor in REIT M&A, though it may be a few more years before that factor kicks in. "The REIT universe of companies has shrunk considerably in recent years," he notes. "It gets smaller with each merger. It may not be long before the pace of deals has to be much slower than we've seen in recent years."

Taylor posits that, going forward, the advantage in REIT acquisitions might go to cash buyers. "Investors still will have some appetite for strong REITs as a way to acquire real estate, but the question will be how to finance the deals," he says. "In the new credit environment, for the foreseeable future, the all-cash buyer will be more competitive."

In some cases, "all-cash" may mean a strategic partnership between a major REIT that's portfolio shopping and a private equity source. Although privatization was the main theme of REIT M&A activity in 2007, such a partnership deal did occur.

"It was harder this year for other REITs to compete to buy REITs, but not impossible," Lindemann says. "In the case of Simon Property Group's (NYSE: SPG) acquisition of The Mills Company, it enlisted the financial assistance of Farallon Capital Management, a hedge fund."

That acquisition, totaling about $7.9 billion with debt assumption, also inspired a bidding war. Had Mills gone to rival suitor Brookfield—fresh from taking Trizec private in 2006—then it too would have been another privatization in 2007. As it happened, however, Simon carried the day with its $25.25 per share cash offer for the troubled Mills.

"Mills' assets are a good fit for Simon, and they pursued a successful strategy to get them," Lindemann says. "The partnership with Farallon allowed Simon to pursue the acquisition without bearing all of the risk. It's a strategy we might see more of going forward."