Philip Blumberg Blog

Blumberg Capital Partners in the News

Philip Blumberg was recently noted in Investment News. Private-equity-REIT buyouts could lead to an IPO surge.

An excerpt:

Market experts are bracing for a possible wave of initial public offerings to hit the real estate world in the next two to five years as many speculate that private-equity firms may use IPOs as exit visas.

Philip Blumberg, founder of American Ventures, a real estate investment management company based in Coral Gables, Fla., speculates troubled property owners needing access to capital likely will resort to IPOs first.

REITs Bounce Back, For Now

As the credit crunch shows signs of easing, shares of commercial-property real estate investment trusts are finally beginning to rally with investors returning to the sector. Total returns for the dozen commercial-mortgage REITs tracked by the National Association of Real Estate Investment Trusts are up almost 16% since the start of April -- compared with a 20.5% decline in the first quarter and an 11.5% decline in the fourth quarter of 2007. The shift in interest could help increase the flow of funding to commercial real estate, but some speculate that we may not be out of the woods yet.

The Wall Street Journal observes that REITs have a history of bouncing back after tough times, as they did after the late 90's property bust, but suggests that there are reasons to be wary. Namely, the concern that defaults could increase if economic concerns deteriorate, and, more directly, that the business model itself may have been rendered obsolete under the weight of the credit squeeze. REITs, acting like leveraged bond funds that only make money if the yields exceed the cost of their borrowings, have allowed companies to depend heavily on the ability to sell securities stuffed with the loans they originated, called collateralized debt obligations (or CDOs) in order to lock in financing for a longer period of time to match their mortgage portfolios with long-term maturities. But today, with the CDO market all but shut, "there is no real long-term debt financing that they can rely on to fund the acquisitions of assets," says Jason Yablon, an analyst at REIT investors Cohen & Steers Inc. in New York. "Their business model is essentially broken."

Daniel Cohen, chief executive of RAIT Financial, doesn't agree with Yablon, and offers another perspective on the current market conditions. "As the liquidity market stabilizes, I believe there will be opportunities for new investments," he says. Several mortgage REITs will give presentations at the investor forum held by the National Association of Real Estate Investment Trusts in New York this week as investors wait eagerly to hear what these companies have to say about the prospects for their business.

For more real estate news and information, visit Blumberg Capital Partners.

REITs, private equity and carried interest taxation

Recent proposals before Congress, one from the Senate Finance Committee and the other, broader one, from the House Ways and Means Committee to raise taxes on private equity and hedge fund managers are causing a lot of comment which, broadly, falls along two lines. On the one hand some pundits say that, if enacted, the taxes will kill the private equity and hedge fund management business. Others argue that it's only just and fair that high-earners pay regular income tax rather than the 15% capital gains tax rate (private equity and hedge fund managers' earnings are assessed as "carried interest," rather than as traditional income).

As a commercial real estate professional who operates investment funds and a REIT (and thus has significant carried interest in several funds), I naturally have a direct concern in anything that might impact the performance of the industry's ability to finance equity, REITs and buy outs. It seems to me that neither proposal will be signed into legislation in their current form. Far from hitting just the high rollers, eroding carried-interest favorable tax treatment would impact hundreds of thousands of individuals who benefit from it in smaller ways -- the proposals would in effect cause widespread fallout in order to snare the handful of people they're really aimed at. Far more likely, in my opinion, is a cap above which tax treatment is normalized -- and therefore not the broad sweeping change as contemplated in the proposals.

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.