REITs looking for capital are turning to joint venture partners to help finance growth. The dollar volume of REIT joint venture activity surged 50 percent in 2015, according to a new EY research report.
One of the key drivers behind the spike in joint venture activity is the current climate for REITs on Wall Street. Many REITs are trading below their net asset values (NAV), which makes accessing capital in public markets more expensive. REITs are also sensitive to taking on more debt, which can impact their credit ratings. “It is not an issue of whether there is access to capital for REITs in this environment. I think it is really a question of whether it is access to the right capital,” says Mark Kaspar, REIT sector leader at EY.
There has been a notable decline in the amount of common equity that REITs are raising in the public market. The total common equity capital raised by U.S. equity REITs dropped sharply from $10 billion during first quarter 2015 to just slightly more than $2 billion in the first quarter 2016, notes Kaspar. That decline could be due to a variety of factors, such as less acquisition activity. “We believe a large part of it is because of the disconnect between NAV and share price,” he says. Although perhaps not dollar for dollar, joint ventures are definitely helping to fill that gap, he adds.
Those REITs that are more actively pursuing joint venture capital are generally in the mall, office or industrial sectors, which are trading at bigger discounts to NAV, notes Kaspar. For them, accessing the public equity markets really wasn’t the best alternative when they can get lower cost of capital and higher private market pricing on their properties through a joint venture structure, he says.
One of the most notable joint venture announcements this year includes Welltower’s joint venture with the Canada Pension Plan Investment Board. The two entities are teaming up to buy a 97.5 percent stake in six Florida-based senior housing properties for a combined price of $555 million.
Forest City Realty Trust also announced in early April that it had completed the second of three previously announced regional mall joint ventures with QIC, one of the largest institutional investment managers in Australia. Combined, QIC will invest $90 million in the three Forest City projects. QIC has acquired a 49 percent equity interest in Ballston Quarter, a 578,000-sq.-ft. regional mall in Arlington, Va. that Forest City is redeveloping. The JV also includes QIC’s investment in Ridge Hill mall in Westchester, N.Y. and a still pending investment in the Shops at Wiregrass near Tampa, Fla.
EY expects joint venture volumes to increase further in 2016. “We think it is a growing trend as people have seen success in these ventures related to the capital access for REITs,” says Mike Straneva, national director of transaction real estate at EY. The three primary uses of that capital will include funding the following:
- Ongoing operations, including paying down or retiring debt, funding future acquisitions or funding the development pipeline.
- Flexibility for REIT management teams’ capital allocation on both sides of the balance sheet.
- Repurchasing shares or issuing special dividends.
Joint venture capital is an attractive source of capital given some of the dynamics in capital markets and the fact that many REITs are trading at discounts to NAV, agrees Edward Mui, a REIT equity analyst at Morningstar. “Part of it also is potential partners just becoming more educated and comfortable with the JV structure, working with REITs and other general partners,” he adds.
To that point, REITs are finding plenty of potential sources of capital via institutions and foreign investors. New regulatory developments are helping to pave the way for greater joint venture activity. The change to Foreign Investment in Real Property Tax Act (FIRPTA) laws makes it easier for foreign capital to invest in the U.S. One other development that is coming to the forefront in August is a reclassification of real estate and REITs in the Global Industry Classification System. Instead of being included within financial services, real estate and REITs will now be the 11th headline sector. “The expectation there is that it will further broaden their reach into the institutional investor community,” says Kaspar.
There also can be some downside to REITs’ use of joint ventures. Bringing in a joint venture partner does not offer the same opportunity to achieve maximum pricing as compared to a competitive bid situation. Another risk for REITs is that they become too dependent on the joint venture structure, notes Mui. Such structures can become a problem with transparency in financial reporting. “It makes it tough for an analyst or investor looking at financial statements to be able to extract the relevant information depending on the level of disclosure that each REIT chooses to practice,” he says.