Posted by:

Joseph Pasquarella

Real estate investment trust (REIT) mergers and acquisitions (M&A) exploded in 2013 with multiple billion-dollar deals.  American Realty Capital Properties acquired American Realty Capital Trust IV for $3.1 billion.  Essex Property Trust acquired BRE Properties for $4.34 billion.  And the trend is already pushing into 2014, with Kite Realty Group Trust acquiring Inland Diversified Real Estate Trust Inc. for $1.2 billion in stock in February.

Why such a flurry of activity? REITs were rocked on share prices last year, and M&A might be the salve.  While the S&P 500 grew 32.4% in 2013, the average REIT return was just 2.7% .  The jump in interest rates last May triggered the cold snap and since then REITs have had to pursue alternative strategies to demonstrate their worth to investors.  And the actions they’re taking to rein investors back in are driven by three opportunities:

1.  Economy of scale operations.  Bigger is better, and REITs held to high standards for growth can get a boost through M&A.  Through roll-ups and acquisitions, REITs are growing their silhouettes in bursts rather than property by property.  And by acquiring more properties, REITs can reduce operating expenses and better pool human resources.

2.  Location, location, location.  Through mergers and acquisitions, REITs aim not only to pad their property portfolios, but also to expand the geographical diversity of their holdings.  Many REITs typically focus on a single area, and by diversifying by location, REITs stand a better chance of maintaining value despite regional issues, such as Detroit’s bankruptcy last summer.

3.  The price is right.  Because REITs have tumbled on the market, acquisition opportunities have arisen as stock prices fail to reflect REITs’ true net asset value.  With agency REIT values 20% below their book value. those with deeper pockets are snatching up what they can.  For example, when Kite bought Inland Diversified Real Estate. it doubled its shopping center holdings to about 20 million square feet, taking advantage of favorable cap rates and lucrative locations.

Retail and apartment REITs stand to gain the most from this phenomenon.  Last year apartments hit a 12-year high for occupancy, with rents riding high.  Yet Bloomberg’s Apartment REIT index slipped 7% in 2013.  The result is acquisitions like Essex Property Trust’s recent purchase of BRE Properties, which was trading at 13% below net asset value, amounting to a hefty discount on high-quality assets.

As 2014 continues, we expect to see more M&A as REITs take advantage of discounts in net asset value to add heft to their footprints.  It’s nearly impossible to meet many shareholders’ expectations by acquiring properties one by one.  Wall Street is looking for strong growth with a healthy trajectory.  Not to mention that larger acquisitions are more efficient in terms of transaction and human resources costs.  So watch for more billion-dollar deals as REITs show the bulls who’s boss.

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