Lead Story… The past couple of years have been challenging ones for commercial REITs. Considered the performance darlings of the US equity markets just a few years ago, the sector has been taking it on the chin as the one-two punch of rising interest rates and bottoming out cap rates take their toll on share prices. What’s particularly interesting about this is that while share prices have plunged, the actual value of the underlying assets generally have not. The fact that so many REITs are now trading at a discount to net asset value or NAV creates an interesting situation for the REITs that are looking to raise cash to help re-position assets or fund share buybacks: there is a very strong financial incentive to sell assets rather than issue new shares. Esther Fung laid out why this is in a recent Wall Street Journal story (emphasis mine):
More real-estate assets owned by publicly listed REITs are up for sale as the gap widens between their discounted share prices and the value of private-market transactions of physical assets.
Shares of real-estate investment trusts have underperformed the broader equity market for the third year running, in part because of rising interest rates, which cause these dividend-paying stocks to lose some of their appeal.
Because it would be difficult to issue new shares if REITs continue to trade at discounts, some are now compelled to sell assets to raise cash to help them reposition their remaining assets or fund share buybacks.
REITs could sell individual assets, sell stakes in assets to other institutional investors and enter joint ventures where they also could earn some management fees, or be acquired entirely and privatized by an investor.
Industry insiders noted that while there are more for-sale signs popping up, these sales aren’t driven by the need to reduce debt because REITs have been more disciplined since the financial crisis, so property prices aren’t likely to fall drastically.
Listed REITs have been net sellers of assets since 2015, according to data from Real Capital Analytics. From January to March 23 of 2018, there were $6.91 billion in disposals, compared with $5.38 billion in acquisitions.
Disposals topped acquisitions in 2017 and 2016, $60.9 billion to $56.1 billion and $71.4 billion to $48.4 billion respectively, Real Capital said.
“There hasn’t been any reprieve in the valuation of REITs,” said Gil Menna, a partner at Goodwin Procter LLP. Asset sales and joint ventures with pension plans, private-equity firms and other institutional investors that have occurred in recent years “should be happening in a bigger way this year,” he added.
Substantial discounts to NAV, like those currently seen in REITs typically do not last forever and their are ultimately only three possible outcomes:
- REIT share prices rise to meet NAV
- NAV falls to meet REIT share prices
- A combination of the two
Green Street Advisors Chairman Mike Kirby – one of the world’s foremost REIT experts – spoke at the NYU Schack Institute of Real Estate Annual REIT Symposium in New York recently and made a case for scenario 2 above. From Globe Street (emphasis mine):
One of the best ways to tell what’s going to happen with private market real estate pricing is to look at the public market, according to Kirby. “The public market right now is saying is something really bad is going to happen to private real estate pricing.”
He added that he did not necessarily fully buy into that. “But you’re also foolish not to listen to it because it is a signal that has worked in the past. When REITs are trading discounts to NAV (net asset values), private market values typically go down over the course of the next 12 to 20 months.”
Kirby distinguished different property sectors. The drop in pricing in the index implies dire times ahead for owners of gateway offices and apartments, particularly in New York. “Those are the asset classes in the public space that are trading at the biggest discounts, meaning the public investors don’t believe private values are accurate. The truth is probably somewhere in between.”
Even if it is somewhere in between, that still means private values will probably go down, not up in those spaces. In good news, the public market indicated industrials are priced right, with a solid outlook. There’s no one answer for all REITs but the index was more down than up, Kirby said.
Investors, beware with malls rated B or lower because even the public stocks are trading at massive discounts. “Really, it’s how long you’re going to be able to clip a coupon and I think the coupon’s going to run out on you before you capture your full return on investment with some of these malls. You’re going to see an awful lot of carnage in these spaces,” he said.
If Kirby is correct, REIT’s have a window to sell properties while NAVs are still high relative to share prices and build up their balance sheets to capitalize on the carnage if/when underlying property values fall as share prices are now signaling that they will. However, there are plenty of other sophisticated investors who are looking at this as a buying opportunity and see REITs as being negatively impacted by wicked volatility swings in the broader equity market. Even Kirby was careful to note that the discount to NAV indicator is not a foolproof one. Either the “REITs are cheap” camp or the “property is expensive” camp will eventually be proven correct. However, only time will tell which side that will be.
Storm Clouds: The US is shrinking its tax base just as interest expenses surge and an aging population make social programs get harder to cut. This is particularly troubling:
Slow growth can be managed with the right fiscal policies. This is where it gets worrisome. In the U.S., interest swallowed 8% of federal revenue last year, the highest of all AAA-rated countries. As interest rates return to normal and debt keeps rising, Moody’s thinks it will hit 21.4% in 2027. This severely limits the government’s flexibility to respond to emergencies, whether a financial crisis, a recession, or a war, not to mention longer-term priorities such as education and research.
Oops: The cost of student loan forgiveness programs has exploded, in part, because policymakers did not correctly estimate the number of students who would take advantage of such programs. Now the federal government is scrambling to reduce forgiveness programs and institute borrowing caps in order to stop the bleeding.
A Decade of (Some) Change: Great visual summary of what has and hasn’t changed since the Great Financial Crisis a decade ago.
Ballooning: Commercial and multifamily mortgage debt in the US hit $3.18 trillion at the end of 2017, up 6.7% from a year prior.
Ground Zero: A developer is trying to build 2,400 housing units on the grounds of a dying mall in Cupertino as part of a mixed use re-positioning play consisting of retail, housing and office space. Residents are not happy but may not have much say in the matter thanks to Senator Scott Weiner’s SB 35 fast track development law, under which this project would fall.
The Empire Fights Back: With (relatively) affordable cost of living as a major draw, population is booming in the Inland Empire.
The Oracle of Real Estate: Warren Buffet is now America’s second largest real estate broker.
Hits Just Keep on Coming: Facebook has found itself in the cross-hairs of fake news scandals for quite some time but its role in subprime advertising scams may be even worse:
Affiliates once had to guess what kind of person might fall for their unsophisticated cons, targeting ads by age, geography, or interests. Now Facebook does that work for them. The social network tracks who clicks on the ad and who buys the pills, then starts targeting others whom its algorithm thinks are likely to buy. Affiliates describe watching their ad campaigns lose money for a few days as Facebook gathers data through trial and error, then seeing the sales take off exponentially. “They go out and find the morons for me,” I was told by an affiliate who sells deceptively priced skin-care creams with fake endorsements from Chelsea Clinton.
Who Would Have Guessed? A recent study found that not all scams are ICOs but nearly all ICOs are scams.
Predictable: An NFL player invested millions of dollars to acquire an iconic Las Vegas strip club. You’ll never believe what happened next.
Chart of the Day
Gonna Leave A Mark: A man (who I’m 99% sure is or was once a member of a fraternity) tried to have sex with a giant clam while scuba diving in Hawaii. The clam was not in the mood and he ended up in the hospital.
Man of the Year: A Toronto chef brought out an entire animal leg and started butchering it adjacent to a window where vegans were protesting his restaurant for serving foie gras. Friendly Reminder: a vegetarian is someone who eats a plant based diet. A vegan is someone who tells you that you should eat a plant based diet.
Shitty Thing to Do: Wisconsin cops are on the hunt for a mystery person costing the city of Sheboygan thousands of dollars in repair costs by repeatedly clogging the toilet inside a women’s public restroom by stuffing 20-ounce soda bottles into it.
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