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Tuesday, May 29, 2007

Merger fever returning to REITs?

The iShares Dow Jones Real Estate Index (IYR) jumped $2.48 today; that’s over a 3% one-day gain. The surge was inspired by the Archstone-Smith deal. The apartment investment firm agreed to be acquired by Tishman Speyer Properties and Lehman Brothers for $22.2 billion. Shares of Archstone-Smith jumped $55.55, to $60.78, in afternoon trading on Tuesday.

Is merger fever returning to the world of REITs?

Twenty-two REIT takeovers were announced last year in deals worth $103 billion, says SNL Financial. That's compared with 11 deals for $29 billion in 2005 and 8 worth $25 billion in 2004. In 2006 half the takeover bids were from other REITs or real estate companies, half from the private equity gang.

As for Archstone-Smith, analysts predicted the price could go higher if another bidder steps in or shareholders hold out for more. With all the liquidity out there, the private equity folks have not been shy about raising their offers.

At $22.2 billion, the deal is large, but it is not unique in the real estate investment trust industry. Many companies have gone private in the last three years, with the most high-profile case being Blackstone's $39 billion purchase of Equity Office Properties Trust in February this year. Many say Sam Zell sold EOP at the peak of the real estate bubble and that Blackstone overpaid. Be that as it may, Blackstone Group has wasted no time selling a big chunk of the portfolio it acquired from Equity Office Properties Trust. The New York private-equity firm has already raised $18.5 billion in asset sales, selling or agreeing to sell properties in New York, Los Angeles and Orange County, Calif.; Portland, Ore.; San Diego; Seattle; and Washington.

What other buyouts have been notable? Crescent Real Estate Equities Co, the Ft. Worth, Texas-based REIT, is being acquired by the real-estate arm of Morgan Stanley for $6.5 billion with debt. This deal however, is not being viewed as the one to light a fire under REITs. Citigroup analyst Jonathan Litt said "The takeout price was consistent with our view that upside in Crescent's shares was limited relative to the execution risk and depressed free cash flow…Crescent has significantly underperformed REITs over the last 10 years, returning 91% versus REITs at 277%."

Another deal involves hotels, not apartments. CNL Hotels & Resorts (CHL) is the second largest hotel REIT in the United States, and owns one of the most distinctive portfolios of luxury and upper-upscale lodging properties. On January 19, 2007, CHL announced execution of a definitive agreement to be acquired by Morgan Stanley Real Estate at a price of $20.50 for approximately $6.6 billion for all the company’s outstanding stock. In connection with this transaction, CHL also announced the sale of 51 hotel properties to Ashford hospitality trust for approximately $2.4 billion, immediately prior to the Morgan Stanley transaction. It is clear the lodging industry will not be left out of the buyout party.

With REIT share prices down lately, there may be a perception that they are as cheap as they are going to get. REITs have been in a multi-year bull market but since late February they have lagged the overall market. On balance, there is still demand for REITs. Blackstone alone, for example, has seven funds dedicated solely to real estate deals.

The buyout focus has mostly been on apartment REITs thus far. Now we have also seen an initial move into the lodging sector. In the search for yield and value, we could see more deals done for REITs of both kinds. At the bottom of the REIT food chain, however, are the shopping mall operators. With a complex cost structure and dependence on consumer spending and economic trends, these kinds of properties are usually less attractive to the buyout artists. When we see the malls being taken private, we will know it’s the end of the party.

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