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Deal Adds Life To Moribund M & A Market

Mortgage REIT Gramercy Capital Corp. (NYSE: GKK) plans to acquire bank building owner American Financial Realty Trust (NYSE: AFR) for roughly $1.1 billion. The deal, which Gramercy announced on Monday, will consolidate two niche REITs with individual exposure to both the debt and equity markets.

Analysts largely endorsed the proposed deal. Many noted that Gramercy will diversify its business by acquiring more than 1,300 well-leased commercial properties. The deal will also eliminate one of the weaker-performing equity REITs. Shares of American Financial were down by roughly 40% for the year through Nov. 2. Office REITs, by comparison, were down just 7.32% this year through the end of October, based on the NAREIT/FTSE Equity Index.

American Financial acts as the primary landlord to several of the nation’s largest banks, among them Bank of America and Wachovia. The portfolio is 98% leased with few leases expiring until 2016.

Gramercy plans to immediately sell roughly $100 million (or about one-third) of the American Financial portfolio. Many of these non-core properties are already under contract, which should help Gramercy reduce its debt costs on the deal: By agreeing to pay $8.43 per American Financial share, or a 31% premium above Friday’s closing price, Gramercy will also assume roughly $2.3 billion in debt.

News of the merger was not entirely surprising. American Financial has long been rumored as a takeout target. The company even carried out a major restructuring and marketing campaign earlier this year that analysts viewed as an overture to potential buyers. But buyout rumors did little to increase demand for American Financial shares.

Banc of America REIT analyst Christy McElroy blamed the REIT’s lackluster performance on its “sluggish future growth prospects and sentiment over its exposure to the financial services industry.” American Financial owns roughly 500 bank branches nationwide, along with 310 office buildings and a 26.1 million sq. ft. land bank.

American Financial management and shareholders will clearly benefit from this deal. So, too, will Gramercy Capital. The Manhattan-based REIT will inherit 27 million sq. ft. of commercial property in 37 states. It will also be transformed into a real estate finance and operating company.

For now, Gramercy originates and acquires whole loans, subordinate interests in whole loans, mezzanine loans and preferred equity interests in companies that own U.S. commercial real estate. The company was a major player in the commercial real estate collateralized debt obligation (CRE CDO) market until the credit slowdown sapped interest in these vehicles.

Gramercy is externally managed and advised by an affiliate of Manhattan-based office REIT SL Green (NYSE: SLG). Gramercy’s close-knit status with SL Green clearly bodes well as analysts say the office REIT has a highly skilled management team. The deal, which has already been approved by both companies’ boards, is expected to close in the first quarter.

Deal Note
American Financial Realty Trust chairman Lewis Ranieri is one of the pioneers of the mortgage-backed securities (MBS) market. The legendary investor worked at Salomon Brothers during the 1980s, where he helped build the firm’s MBS business. Business Week called Ranieri “the bond trader who turned home loans into tradable securities”.

The debt innovator has worked through credit crunches before. During a Monday conference call with analysts, Ranieri said that the debt financing market for real estate had “closed up.” He then asked: “How long would it take to harvest the vacuum and put ourselves back into the position to get additional debt to grow the company?”

Since he agreed to sell the company, the answer was apparently too long.

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