(Istock illustration by Kevin Rebong)
Alex Sapir, whose family famously sold 11 Madison Avenue in New York for a record $2.6 billion, recently went shopping for real estate. But instead of buying a trophy asset or two, he decided to buy a whole company’s worth of them.
In March, Sapir and an investment team he helped pull together made an offer to buy the publicly traded office REIT Columbia Property Trust for $2.4 billion with plans to take the company private.
Columbia Property’s portfolio of high-quality office buildings in cities like New York, San Francisco, Washington, D.C. and Boston is full of question marks as major tenants decide whether they need as much office space post-pandemic. That creates a window of opportunity for Sapir and his partners and could embolden other investors who have long thought that certain sectors of the REIT industry make good targets for privatization.
“I think any asset class that’s been battered by the pandemic, private capital probably addresses that better,” said Jay Bernstein, who leads the REIT practice for the law firm Clifford Chance.
Talk about privatization in spaces like malls and office buildings has been around as long as REIT executives and shareholders have complained that Wall Street doesn’t fully recognize their value. Many watch enviously as properties trade at attractive yields in private markets, only to see stock prices lag behind.
But in recent months there have been a handful of events pointing to some momentum behind the take-private movement. In November, the activist investment firm Bow Street, which had recently emboldened fellow agitators by winning a hard-nailed activist campaign at Mack-Cali, made an offer to buy the $2 billion office REIT Paramount Group at a discount of about 30 percent to where the stock was trading pre-pandemic.
And in April, the financial behemoth Brookfield Asset Management announced it had sealed the deal to take its real estate arm, Brookfield Property Partners, private at a cost of $6.5 billion.
The recent activity could be just the start of another great wave of REIT privatizations, industry pros say. But much like investors who hoarded cash over the last year to buy distressed properties that have yet to materialize, experts warn that the buzz could fizzle.
John Worth, head of research at the National Association of Real Estate Trusts industry group, said there were 14 REITs taken private during the last major economic downturn, when public real estate companies were more overleveraged and investors had a better sense of the long road they were facing to recovery.
“This is not by any stretch of the imagination a repeat of what we saw during the great financial crisis,” he said.
The pandemic has certainly helped raise expectations for those who think they can buy shares of REITs at bargain prices as a way to get at their valuable real estate. Owners of hotels, malls and office buildings not only saw their stocks severely impacted by the pandemic, but they face existential questions about the value of their properties.
“Blinded by the brightness”
The worst-performing REITs lost 25 percent of their market value at the bottom of last year’s sell-off, according to Green Street Advisors. But that turned around in November on news of a vaccine. Stock prices have recovered so vigorously that analysts wonder if investors are being too optimistic.
“Much as the market became fixated on the darkness of the Covid tunnel last year, it could well be that it is now blinded by the brightness,” Green Street wrote in an investor note in March.
The uncertainty only adds to the pressure faced by managers of REITs that trade at a discount to their net asset value — many of whom have been proselytizing for years about the day when Wall Street finally prices them at what they deem to be a fair value.
For the past six years, Vornado Realty Trust CEO Steve Roth has grumbled about what he views as his company’s heavily discounted stock. In his annual chairman’s letter in April, he pointed out that Vornado’s stock price values its buildings in the $500s per square foot, while the replacement costs are between $1,200 to $1,400 per square foot.
“Our stock is once again stupid cheap,” he wrote.
There are several explanations given for why Wall Street values REITs lower than investors value the underlying real estate. One big one has to do with different investment philosophies: Stock investors tend to favor earnings growth, while real estate investors prize long-term value appreciation.
For stockholders who receive a buyout offer, that means it’s a waiting game. Do they hold onto the shares hoping one day they’ll climb to a price no one’s ever sure they’ll reach? Or do they take an offer when there’s money on the table?
Managers are largely optimists who think they can turn a struggling ship around, meaning potential buyers often have to roll up their sleeves in order to convince them to sell.
“People look at the REIT space and think management teams don’t want to go away,” said SunTrust REIT analyst Michael Lewis. “By its nature it almost has to be hostile.”
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That’s what Sapir and his investment team are doing with Columbia Property Trust. Arkhouse Partners, the company co-founded by a former Sapir employee in 2016 that’s leading the buyout effort, started eyeing Columbia as a potential acquisition in the fall. By November, the activist investors realized they needed to act fast.
The REIT’s rules require investors who want to nominate potential board members to be voted on for its annual shareholders meeting in May to do so by December. Arkhouse filed notice on Dec. 1 that it planned to run an activist campaign to replace Columbia’s board of directors. Arkhouse eventually disclosed that it and its partners had built up a position equal to 3.3 percent of Columbia’s shares.
In a letter to fellow shareholders explaining its push to replace the board, Arkhouse blamed the directors for a failed sales process in 2018.
“We believe the board has failed in the past to thoroughly explore transactions that could have allowed long-suffering stockholders to realize Columbia’s intrinsic value and enabled the company to be sold to a buyer interested in operating outside of the unforgiving public market glare,” they wrote.
Columbia said it’s reviewing the Arkhouse offer and recommended shareholders reject their slate of board members.
Sapir and Arkhouse made their offer at $19 per share, a premium over the $15 per share the stock was trading at the time.
SunTrust’s Lewis, who covers Columbia, said shareholders have to consider if, or when, the company’s stock will rebound to the roughly $20 per share it was trading before the pandemic hit.
“Are you going to be comfortable with a $15 stock?” he asked. “If you don’t take this now, there’s no guarantee when the stock will be trading at $20.”
Generous or “wholly inadequate”
Arkhouse and Sapir’s offer could be considered a generous one, given it didn’t deeply discount Columbia’s price for the pandemic. By contrast, Bow Street’s bid for Paramount Group late last year came in around $9.50 to $10 per share, below the nearly $15 per share it was trading at in February 2020.
Paramount rejected the offer, calling it “wholly inadequate” and accusing Bow Street of trying to pounce on the banged-up stock. But Paramount is in a unique position to turn its nose up at any offer, considering that the wealthy German Otto family that founded the company holds enough shares that it can thwart any activist campaign.
For Brookfield Property Partners, observers said the decision to go private was fueled by its parent’s plans for growth. Brookfield Asset Management had been the largest shareholder of its real estate arm that paid out a high dividend, which restricted its growth. That had been particularly troublesome for a company like Brookfield Property, which has a large portfolio of malls that needed investment even before the pandemic hit.
Brookfield Asset’s plan to take the company private, experts said, is driven by its strategy of investing in the company without its stock being penalized in public markets.
“The structure [of Brookfield] leads to a lack of free cash flow that limits the opportunities to grow,” REIT analyst James Sullivan of securities brokerage BTIG told The Real Deal in February.
Despite Brookfield’s relatively high leverage, NAREIT’s Worth argued that public real estate companies have stronger balance sheets now than they did heading into the Great Recession, which he said has made them more prepared to resist the kind of buyout activity that happened last time around. Shareholders believe that the pandemic is only short-term for most sectors, Worth said.
“If investors can see a light at the end of the tunnel, why would they sell?” he said.
But some REITs have long had to defend their existence. Critics say the publicly traded model prioritizes quarterly performance and leads to short-term thinking, a financial setup that doesn’t work well for properties that need large sums of capital for improvements.
On the other hand, Wall Street also provides attractive streams of financing for companies that can tap the public markets.
Scott Rechler has been on both sides of the divide.
He ran his family’s publicly traded company Reckson Associates Realty before selling to the REIT SL Green Realty and then launching his own privately held firm, RXR Realty.
Since Rechler sold his company for $4 billion in 2006, office REITs have traded at a discount to their net asset value on 94 percent of trading days, he said. It’s an anomaly for an office REIT to be valued in line with its real estate, he added.
“I think that’s the question: Is the REIT model the best model to own real estate in?” he asked. Rechler predicted there could be more buyouts coming.
“I think if it gets to the fall and things are still depressed,” he said, “you’ll start to see more activity.”