EDITOR'S LETTER: Shaking the Rafters
Dec 1, 2006 12:00 PM, David Bodamer
Mergers and acquisitions are the way of the business world.
But some deals mean more than most — not just because of their dollar amount, but because of what they represent.
AOL acquiring Time Warner signaled the height (and the absurdity) of the tech bubble. The bank mergers in the late 1990s reshaped the landscape on Wall Street. And Kmart buying Sears officially recognized the decades-long weakening of department stores and the fact that in Wal-Mart's world, other retailers need to take extraordinary measures to try and compete.
For real estate, the watershed deal is now Blackstone Group's monumental $36 billion acquisition and privatization of Equity Office Properties — the second largest REIT in the United States. We all knew private equity had a mountain of cash and that it has been stalking REITs. Such firms have been taking REITs private at a breakneck clip for the past two years. Blackstone itself has now been part of $83 billion worth of REIT privatizations since 2004.
But this deal is different.
It is nearly three times the size of the previous record-setting real estate deal (General Growth Properties' 2004 acquisition of Rouse Co. for $12.6 billion.) More importantly, it proves that any REIT can be bought.
You didn't have to draw a diagram for investors, who quickly piled into REIT shares, hoping to profit from the next takeover. Simon Property Group, General Growth Properties, Vornado Realty Trust, and Kimco Realty Group all hit 52-week highs in the days following the news of the Equity Office deal. The Morgan Stanley REIT index jumped from 1,054.52 to 1,108.61 (an all-time high) in two days.
What hasn't happened (yet) is a major takeout by private-equity buyers in the retail real estate space. Private-equity funds have been active in retailing, but the biggest deal in retail real estate per se has been GE Capital's $3 billion bid for Trust Street, a net lease outfit that focuses on restaurants.
Given the speed with which private-equity investors are marching through the U.S. economy, the focus may have shifted to retail real estate by the time you read this. If it hasn't yet, we think it's just a matter of time.
As our cover story — starting on p. 28 — makes clear, the climate in the retail real estate market has cooled considerably. Investors have moved on to other property types that offer more potential and deal volume has fallen. With cap rates only beginning to budge and the fundamentals of the business weakening, analysts figure that 2007 will be a slow deal year, too.
But now that we know that size is no obstacle to private equity buyers and that they like companies that are perceived to be undervalued, regional mall REITs emerge as the most likely takeover targets in the retail REIT sector.
Several firms, including Macerich Co. and General Growth Properties, are now trading at a discount to net asset value, according to consensus estimates. And some have hit a rough patch this year, falling short of FFO targets.
Part of the problem is that rental growth has suddenly slowed for regional malls. During the third quarter, average rent per square foot for new and renewed leases at General Growth were down 9.2 percent compared with a year ago. In contrast, Developers Diversified, with its community center portfolio, saw rents increase 15.5 percent over the same period last year.
And preying on weakness is how private equity seems to work. When retail shone, private equity buyers went after everyone else. Now that retail is at the back of the line, 2007 looks like the year where retail privatizations begin in earnest.
Resistance is futile.
David Bodamer
Editor-in-Chief
Retail Traffic Magazine
