Some of the most active areas in real estate today are being driven by operating companies and investors eager to monetize the value trapped in their real estate holdings. Both can benefit via such methods as non-recourse financing, sale-leaseback transactions and, increasingly, REIT conversions and spinoffs.
Whatever the method, in a healthy real estate market these types of transactions can broaden investment opportunities for those investors—particularly activist investors—seeking yields that are backed by hard assets.
There is certainly significant activity here. During 2013 and 2014, 24 new U.S.-based REIT initial public offerings came to market, raising $9.7 billion, according to the National Association of Real Estate Investment Trusts. And CoStar Group indicates that 2015 is poised to be one of the most active years in REIT IPOs, with more than 30 companies weighing potential REIT conversions or offerings.
Perhaps more illustrative of this monetization phenomenon is the total market capitalization of recent REIT conversions/spins, which totals a hefty $126.5 billion since 2011, according to a compilation of publically available transactions by consulting firm PwC.
This activity isn’t restricted to “traditional” real estate, such as office buildings, apartments, retail centers, malls, industrial warehouses and hotels. While many monetization transactions still involve these types of real estate, more recent transactions have been created in such non-traditional industries as timber, cell towers, billboards, utility infrastructure and telecom infrastructure—in short, virtually any vertical where significant real estate is owned. In the future, we could see similar spinoffs in railroads, docks and marinas, toll roads, bridges and even landfills.
There have always been cycles that favored owning real estate, but today we’re seeing an aggressive shedding of these assets. Why? Perhaps the existing corporate real estate function was originally designed to support out-of-date operations, or the real estate structure originally was motivated by financing, accounting or tax considerations that no longer apply.
Whatever the motivation, the result is the same: Those elements of real estate-intensive companies that enjoy predictable rental income are often being separated from their more cyclically-oriented parents. Those parents, in turn, are now freed from the capital intensity of real estate, and can offer higher equity returns by investing in higher ROI-yielding activities.
These kinds of transactions are transformative events. They are designed to create growth capital for a more vibrant corporate future. And investors, who are seeking companies they believe offer hidden value that can be unlocked through changes in structure or divestitures, are finding new opportunities of their own.
These transactions can be very tax-efficient. For example, a leaseback can be structured as a tax-free spinoff (which then elects to be a REIT). Here, it reduces the tax “toll charge” incurred by spinning off leasable real estate from the corporation and its corporate-level taxation. Further, if the new REIT is structured as an umbrella partnership REIT, or UPREIT, it may allow for the use of a kind of tax-advantaged currency, called an “OP unit,” that can be used to acquire additional properties, generally on a tax-deferred basis.
In our view, it’s possible for everyone to win this way. Companies can sell or spin off assets, realize proceeds and lease back the assets they need for operations. Meanwhile, in certain structures, investors get to choose their investment vehicle depending on their perceived appetite for risk—real estate stock for its steady dividends, or operating company stock for perceived growth opportunities.
It’s not yet clear whether these monetization transactions are part of a long-term trend. And for those companies with substantial real estate holdings, it’s not a process to be undertaken lightly.
The conversion/spin-off process is highly complex (tax, legal, regulatory, operational, etc.). It can be a long, daunting task, fraught with potential pitfalls, and may be costly and difficult to reverse.
But given the resurgent real estate market, the investment opportunities for those seeking decent yields and the need to unlock underperforming assets, real estate monetization transactions—including REIT spin-offs—should be with us for some time to come.
R. Byron Carlock Jr. is a principal and the national real estate practice leader at PricewaterhouseCoopers. He can be reached at [email protected]. He collaborated on this column with Tom Wilkin, a real estate partner and U.S. REIT leader at PwC, who can be reached at [email protected].