After a challenging start in 2010, this year is looking to be a better bet for REIT initial public offerings.
Today, many firms are looking at increasing the pace of their acquisitions, as the investment sales market shows renewed vitality. To finance those transactions, some would like to tap public equity and debt. Many firms had a similar thought last year and planned IPOs, but had to back off after getting chilly receptions from investors concerned about retail real estate’s outlook. But things are looking up in 2011, which could translate into more retail REIT IPOs.
“I think there were a lot of guys who wanted to go public [last year] but didn’t, because they didn’t think the conditions were right,” says Rich Moore, an analyst with RBC Capital Markets. “Today, there is recognition that commercial real estate will be fine, if not great. The retail guys are definitely going to think about IPOs.”
Last week, for example, American Assets Trust Inc., a San Diego, Calif.-based firm that specializes in retail and office properties, sold 27.5 million initial shares at a price of $20.50 apiece, raising approximately $563.8 million. American Assets’ shares priced at the higher end of its expected range, which was initially set between $19 and $21. The transaction was also the largest REIT IPO in more than a year.
Also, in December, Schottenstein Realty Trust, a Columbus, Ohio-based owner of office, retail and industrial properties, filed a statement with the SEC indicating its plans for an initial offering. Schottenstein operates 109 retail centers, totaling 11 million square feet of space.
American Assets plans to use the money for acquisitions, to repay its debt and for other working purposes.
It’s a stark change from a year ago when some firms were forced to cancel offerings. For example, DLC Realty Trust, a Tarrytown, N.Y.-based private REIT which specializes in grocery-anchored shopping centers and power centers, postponed its IPO indefinitely after its shares priced significantly below expectations. (DLC valued the company at $15 to $17 per share, but had to lower the price to $12 to $13 per share before opting to delay the offering.)
And both Excel Trust Inc. and Whitestone REIT, the two retail REITs that did complete IPOs in 2010, had to lower their share prices before entering the public markets. Excel, a San Diego-based shopping center REIT, had to cut its price 22 percent, to $14 per share. Whitestone, a Houston, Texas-based REIT that specializes in community centers, had to accept $12 per share, after setting an initial range between $14 and $16 per share.
Overall, nine REIT IPOs in 2010 raised about $2 billion. In 2011, the number may be higher. As of Jan. 10, there were about 12 REIT IPOs “on file or waiting to launch,” according to a report by SNL Financial, a Charlottesville, Va.-based research firm.
In fact, in 2011, conditions seem particularly favorable for retail REIT IPOs. Retail REITs ended 2010 with the highest increase in total returns in six years, at 33.41 percent, according to NAREIT. They significantly outpaced the S&P 500, says Robert McMillan, a REIT analyst with New York City-based Standard & Poor’s Equity Research.
In addition, most publicly traded retail REITs today are trading at or above their fair value, notes Todd Lukasik, senior equity analyst for the real estate sector with Morningstar. The fact that occupancy levels at malls and shopping centers began to shape up in the second half of 2010 likely made investors more confident in the sector’s impending recovery. At the same time, there remains some room for leasing spreads to improve in the coming months, creating a potential for upside, notes McMillan.
Usually, investment bankers see some risk when they see an IPO,” says James C. Mastandrea, Whitestone’s CEO and chairman of its board of trustees. “Now that they see where we are trading, there is more interest in us.”
Risk perception was likely at the heart of the troubles DLC, Excel and Whitestone experienced with their share prices last year, according to Michael R. Grupe, executive vice president of research and investment affairs with NAREIT. In the summer of 2010, the outlook for commercial real estate remained dim and the retail sector in particular had yet to emerge from its three-year funk. As a result, REIT investors added a sizeable risk premium to any new REIT shares hitting the market, Grupe notes.
“When you are talking about an IPO, the market’s judgment about the risk is not transparent,” says Grupe. “The investors are all operating blind and when that happens they will build a higher risk premium into the price they are willing to pay. And whenever you have an event taking place in the market that increases the level of uncertainty [for example, the raging financial crisis in Greece that for a while threatened the global economy] that increases the risk premium.”
This year, the companies that stand to gain the most from IPOs will be those that already have established property portfolios that investors can analyze, says Lukasik. Firms with few or no holdings will likely be discounted as too risky.
In addition to assembled portfolios, equity investors want to see evidence of an experienced management team, financial discipline and a product or service that offers a compelling “story,” according to Moore and Grupe.
Still, while 2011 may beat 2010, it will be a far cry from the industry’s peak year in 2004, after the last recession. Then, the sector saw 29 new offerings, according to NAREIT data.
This time around, the fallout from the financial crisis will lead to a more protracted recovery period, says Grupe. In addition, while there is certainly plenty of equity out there looking to invest in commercial real estate, companies contemplating IPOs face stiff competition from existing REITs.
In 2010 REITs were aggressive in tapping debt and equity in secondary offerings. The sector raised $26.3 billion in secondary offerings and $19.2 billion in unsecured debt offerings, according to NAREIT.