The REIT Slowdown

Although we still have four months left in the year, it’s not too soon to say that 2010 has been a disappointing year for REIT IPOs – both in terms of the number of IPOs, the offering price and the performance after going public.

It’s true that much of the disappointment stems from the deflation of such high expectations. In mid-2009, as REIT stock prices increased and investors showed significant interest in REIT equity offerings, many industry experts forecast an increase in REIT IPO activity.

However, the ongoing volatility in the stock market and apathetic response from investors has caused plenty of disappointment for wannabe REITs—leading them to restructure their offerings at a lower price, postpone their IPOs or even scrap them altogether.

“I really thought we would see a slew of REIT IPOs in 2010,” says Martin Luskin, a partner with Blank Rome LLP. “Instead, we’ve seen a lot of deals get shelved or postponed.”

In early 2009, several events occurred to indicate that REIT IPOs would be well received in the market.

First, investors made it clear that they were frustrated with open-end private real estate funds that had far less liquidity than REITs, Luskin says. In early 2009, investor redemption requests spiked and forced the majority of open-end private funds to halt redemptions.

One way to avoid the illiquidity of these funds would be to invest in publicly traded REITs, and many industry experts believed institutional investors would reallocate a percentage of their funds into listed REITs. Investment banks and real estate owners saw this as an impetus to create REITs.

Secondly, many commercial property owners were faced with debt maturities on existing assets and an inability to access debt, either to refinance their properties or in the form of lines of credit to start new projects. Given the state of the acquisitions market, owners didn’t have the option of selling their properties, either.

These owners that needed to recapitalize their companies or their portfolios saw going public as a solution to their problem, says Scott Westphal, managing director of securities for Cornerstone Real Estate Advisers, one of the world’s largest real estate investment managers.

Lastly, many real estate players wanted to take advantage of the wave of distressed properties or distressed debt that was expected to occur in 2010. As a result, a number of blind pool REITs – entities that have no assets when they go through the initial offering, yet have plans to invest that money in a particular product type – were filed in 2009 and earlier this year.

During the last 18 months, there have been 15 REIT IPOs: nine in 2009 and six through June of 2010. Last year, REIT IPOs raised $3.1 billion, and this year, they’ve raised $864 million.

During that same period, 15 REIT IPO filings totaling more than $6.2 billion have been postponed or withdrawn, and another 15 REIT IPO filings totaling $4.5 billion are still active.

Of the nine companies that went public in 2009, all except one – Government Properties Trust – was a blind pool REIT. However, the wave of distress that the market expected has yet to materialize, and all blind pool REITs that went public in 2009 (with the exception of one) are trading at a discount to the offering price.

CreXus Investment Corp., for example, went public in September 2009 at $15 per share and as of July 16, the stock was trading at $16.29 per share – a 20 percent discount.

“I think the blind pool REITs have struggled,” Westphal contends. “It was difficult for them to go public, and for the most part, they’ve gone public and been unsuccessful.”

In fact, 13 of the 15 postponed or withdrawn REIT IPO filings were blind pool REITs. The other three – Americold Realty Trust (cold-storage industrial assets), Northstar Healthcare Investors (senior housing properties) and Welsh Property Trust (Midwest-focused office properties) – were restructured many times before their executives put the deals on hold. Welsh originally planned to raise more than $300 million, which would have ranked it as the largest REIT IPO so far in 2010.

Of the six REIT IPOs in 2010, three were blind pool REITs. Of the other three REITs, only one of them, Hudson Pacific Properties (office REIT), priced within its target range, albeit at the lower end at $17 per share. The REIT ended up raising $250 million instead of the planned $265 million.

The Hudson Pacific IPO was only the second REIT IPO to price within its offering range since October 2007. However, the company’s shares today are trading below its offering price at $16.30 per share.

The other two non-blind pool REITs that went public this year – Piedmont Office Realty (office REIT) and Excel Trust (shopping center REIT) – priced below their offering price.

Piedmont, which priced at $14.50 per share, had initially filed to raise $345 million and ended up raising only $173 million. Today, it is trading at $17.03. Excel Trust, which priced at $14 per share, initially expected to raise $300 million and closed its offering with only $210 million. Today, its shares are trading at $10.95 per share.

Westphal says investors have been burned by the recent REIT IPOs because most of the companies are now trading below their offering price. As a result, they’re focusing on valuations.

“For the companies looking to the public markets to recapitalize their companies, one of the challenges has been valuations,” says David Lazarus, senior managing director of EdgeRock Realty Advisors, a real estate investment bank based in New York City. “Investors are placing a lot of scrutiny on the valuations to make sure these companies are coming in at the right price. They’re saying that they want to buy at a discount and want the stocks to trade up.”

Lazarus, who served as financial advisor to Hudson Pacific Properties on its recent IPO, notes that investors are comparing wannabe REIT portfolios with existing REIT and admits that it’s possible that investors are judging these companies too harshly.

“I don’t think that it’s fair to hold these companies up to the bellweathers of the industry,” Lazarus says. “By the same token, they can’t say they want to price off the bellweathers, either.”

Westphal says investors are linking companies’ motivation in going public to their valuations, particularly those that seek public status because they need the equity and otherwise would not be able to survive.

“I think the market is speaking volumes about what investors think of the deals,” he notes. “The market is looking for companies with the right motivation – those that have strong sponsorship, quality assets and a good plan for growth. We will welcome them if they come with the right intentions. If they don’t, I think they will get a rude reception.” (credit gre)


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