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REITs Ramp Up Acquisitions as Portfolio Fundamentals Improve

Publicly traded REITs continue to lead the recovery in the commercial real estate sector judging from the presentations made at this week’s NAREIT conference in New York City.

Last year, most companies were focused on shoring up portfolio metrics and getting rid of non-core assets. Today, the focus for many REITs has switched to making opportunistic acquisitions, particularly through off-market transactions with private owners.

Noting that REITs delivered total returns of 31.40 percent over the past year, outperforming S&P 500, Brad Case, senior vice president of research and industry information with NAREIT, says that “investors have recognized that REITs are going to be the winners [in this cycle] and will be able to acquire properties.”

Why now?

Several factors have converged to create the perfect environment for the REITs to make opportunistic plays. First, property fundamentals in most of the major sectors have been improving.

Today, retail REITs find themselves in a position where they can concentrate on raising rents, instead of just battling vacancies, according to Stephen Lebovitz, president and CEO of CBL & Associates Properties Inc., a Chattanooga, Tenn.-based regional mall owner.

Executives with Monmouth Real Estate Investment Corp., a Freehold, N.J.-based REIT that specializes in net-leased industrial properties, report that occupancy within its portfolio now stands at 97 percent.

Senior managers with AvalonBay Communities Inc., a Washington, D.C.-based apartment developer, say demand for space continues to rise, propelled by job growth, troubles in the housing market and lack of new supply.

Even the office sector, which tends to lag economic recovery by some months, is starting to experience a resurgence in demand, although at a very slow pace, according to Edward Fritsch, president and CEO of Highwoods Properties Inc.

Highwoods, a Raleigh, N.C.-based REIT, operates office, industrial and retail properties, primarily in the Southeast.

Lingering signs of trouble are particularly evident in suburban office buildings populated by smaller tenants, according to Randall Griffin, CEO of Corporate Office Properties Trust, a Columbia, Md.-based REIT that specializes in office buildings and data centers leased to U.S. government services.

Nevertheless, even in the office sector tenants are starting to think about future expansion, which means the worst of the fallout from the downturn has already occurred.

This is happening at the same time that REITs finally have easy access to capital and as property values are rebounding enough that sellers have strong motivation to close transactions.

Over the past two years, REITs have been working diligently to clean up their balance sheets and, as a result, the industry’s average debt to market capitalization ratio now stands at approximately 39.9 percent, in line with the historical average, according to Case.

That means that most REITs can now complete new acquisitions without jeopardizing their financial health.

Private misfortune

At the same time as REITs find themselves in a strong financial position, many private owners now have to deal with banks cracking down on underwater loans.

While over the past two years the banks’ mantra has been to “extend and pretend,” the banks have now recovered enough that they can finally recognize losses on bad commercial real estate loans, notes Michael Grupe, executive vice president of research and investor outreach with NAREIT.

It continues to be challenging for owners on the private side to secure refinancing, which means that many of them will now be forced to put their properties on the market.

In many cases, these will be just the kinds of properties the REITs are looking for, where the distress is at the loan level, not at the property level.

In a way, what’s happening today is “a replay of what we saw in the 1990s, in terms of REITs buying assets at the bottom of the market,” from private owners, says Case.

“Certainly opportunities have already been arising, so REITs look for the assets and then look for the capital to buy those assets with,” emphasizes Case.

In 2010, U.S. REITs completed 91 secondary equity offerings, raising more than $23.6 billion. This year, REITs will continue to put new shares on the market on a large scale, both to pay down debt and to raise money for acquisitions, Case notes.

Already in the first five months of 2011, the industry saw 51 secondary debt offerings and raised $16.8 billion.

In fact, many REITs are actively looking for properties that would fit within their portfolios, and either acquiring the assets themselves or with joint venture partners. The issue so far has been finding the right assets at the right prices.

The bidding on core properties has become aggressive and REIT executives across all sectors report that cap rates in many cases have come back to 2006 levels, or within a close range of where they were at the peak at the market.

For many REITs, the economics on those kinds of transactions don’t make sense in today’s environment. “The frothiness is back,” says Griffin of Corporate Office Properties Trust.

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