Philip Blumberg Blog

T-bond surge boosts REIT acquisition potential

Recent developments in the Treasury bond market have borne out some of the reasons I said Real Estate Investment Trusts (REITs) were attractive investments as buy out targets (see my previous post on this topic).

Rising interest rates and the consequent surge in yields has made Treasury bonds more attractive to investors -- especially in a real estate downturn. Unsurprisingly, the Dow Jones Wilshire REIT Index has fallen 6% in the first two weeks of June, and is down almost 15% from its record high in February this year -- remember, the Index rose 31% in 2006.

Vornado's valuation fell almost 17% in one week in mid-May. Other big players, like Mack-Cali and SL Green were also off significantly. By June, analysts like David Fick at Stifel Nicolaus were downgrading the entire REIT sector based on anticipated lower dividends. They argue that average REIT yields at 4% are 1.2% below the 10-year T-note yield. Fine... but, as I've said for some time, valuing REITs on cash flow and dividend yield overlooks the importance of net asset value -- the breakup value of the assets, which is really what makes a REIT attractive to financial buyers.

Paradoxically, the surge in T-yields could make REITs better acquisition targets: traditionally, the high dividend yield they paid drew in institutional investors who, according to Pension & Investments magazine, had $72 billion invested in REIT equities at the end of 2006. So, if REITs are less of a deal based on dividend, and with their equity values falling, the value of their underlying assets relative to cash flow or income or any other traditional accounting measure improves. Which makes them more attractive targets to LBO and private equity investors.

Philip Blumberg Discusses REITs

I recently wrote an article explaining why high break up values mean Real Estate Investment Trusts (commonly known as REITs) are ripe for acquisition. You can find it here if you're interested, but I thought I'd post a short excerpt here as well to explain why REITs are inefficient structures for commercial property ownership:

1. Corporate Structure. The downside of a REIT's main benefit -- an inherent tax advantage -- is that the REIT corporate structure is burdened with severe limitations in terms retaining cash (which severely undermines options against possible takeovers) and restraints on operating freely (which constrains monetization options).

2. Management. REIT managers frequently have to manage for the equity markets' quarterly expectations rather than for the long-term opportunities of the commercial real estate market; the resulting mismatch between corporate- and asset-management policies distorts investment decisions.

3. Valuation --- REITs are mistakenly seen as operating companies by the public markets, which value them as a blend of aggregate cash flow, corporate strategy, and public market and sector interest. This simplistic approach ignores the sum of the breakup value of the individual assets -- which, in a real estate context, is really all that a portfolio of properties consists of.

All this makes REITs good takeover targets. For this reason, American Ventures includes the ability to acquire REITs in current open-ended funds. In fact, we're considering launching a real estate hedge fund to specifically target REIT acquisitions.