Cash, Stock and the REIT Market

For REITs seeking to invest, a big benefit lies in their ability to use stock instead of cash, which allows them to keep leverage low while still pursuing opportunities with private sellers.

Investment opportunities are increasing today, but many remain still to be realized, according to discussions during yesterday’s NYU Schack Institute of Real Estate 16th Annual REIT Symposium. More flexible investors may find better opportunities with a little more creativity.

For Avalon Bay Communities Inc., that means a combination of investment and development for diversification, yet chairman and CEO Bryce Blair prefers development. Acquisitions are expensive, he noted during the panel “The Next 24 Months,” with cap rates averaging 5 percent and even 4 percent on the West Coast, resulting in unlimited IRRs in the 7.5 to 8 percent range. Development, however, offers 6.5 to 7 percent internal yields and IRRs around 10 percent–a third better than acquisitions.

On the other hand, large-scale shopping-center development is still years away, says David Henry, president and CEO of Kimco Realty Corp. Retailers still have too many choices to make new construction viable, and nobody wants to wait years for that construction to take place. With the difficulty of obtaining financing a further roadblock for private investors, however, it does create a more favorable market for existing properties. He predicted that supply will remain constrained for a long time to come.

As for distressed properties, few have come to market thus far, mostly because banks have been able to extend the loans, but Ronald Havner Jr., president and CEO of Public Storage Inc., encourages investors to “be patient.” The huge volume of loans coming due during the next five years “will provide us all with a lot of opportunities.”

That may be much appreciated, since by then prices for other properties are likely to be even more difficult to justify, as pricing may increase faster than is being currently predicted, warns Ed Walter, president and CEO of Host Hotels & Resorts. He views that favorably, since it will raise replacement costs and thereby further constrain new supply. But for buyers, it will mean a greater need to pursue alternative means of financing.

“Finance anything you can today. Hedge anything you expect to be financing in the near term,” said Ric Clark, COE of Brookfield Properties Corp., during the panel “Managing the Balance Sheet.” He believes the government is at this point less likely to get involved to try to keep rates down. Mack-Cali Realty Corp. President and CEO Mitchell Hersh takes that one step further and warns there could be a “second leg down” as a result, especially since corporate America is still cost cutting and not doing much new hiring.

For REITs seeking to invest, a big benefit lies in their ability to use stock instead of cash, which allows them to keep leverage low while still pursuing opportunities with private sellers. Lazard Freres & Co. took this opportunity a step further in its trade of the private Atria Senior Living Group portfolio to public Ventas Inc., notes Matthew Lustig, vice chairman of U.S. investment banking and head of real estate. In the $3.1 billion October 2010 deal, Ventas traded just under 25 million shares of stock and just $150 million in cash for 118 communities, and Atria’s management company retained oversight of the portfolio.

Merrie Frankel, vice president and senior credit officer at Moody’s Investors Service, says she expects more transactions financed with stock going forward. She also recommends financing with unsecured debt rather than secured, since at least during a recession that allows the property owner to level up as necessary.

ProLogis CEO Walter Rakowich, currently in the midst of a merger with AMB Property Corp., at the end of which he has already announced a long-delayed intention to retire, notes that for managers of private companies that are willing to give up management duties, such trades can offer a tremendous opportunity.

Also expect to see more follow-on offerings, notes Jackson Hsieh, vice chairman and global head of real estate, lodging and leisure for UBS Investment Bank. It works better for large deals than small ones, he says, but “that form of currency is very favorable.”

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