In April, Associated Estates, a Richmond Heights, Ohio-based apartment real estate investment trust, agreed to sell itself to a real estate fund managed by Brookfield Asset Management for approximately $2.5 billion. The transaction was the culmination of a 10-month process that involved the Stamford, Connecticut-based activist hedge fund Land and Buildings repeatedly calling for the sale of the company. Associated Estates’ $28.75-per-share sales price represented a 65 percent premium to the price prior to Land and Buildings’ public involvement in June 2014.

The Associated Estates sale is one of the few activist-led deals that has involved a private equity real estate firm in recent years. However, shareholder activism, and the REIT space in general, nonetheless has become a topic of increasing interest for many in the private equity real estate industry.

“Many of the investors in the private world are commenting that it’s hard to find real estate at pricing that they want to buy at,” says Jonathan Litt, founder and chief investment officer at Land and Buildings, which currently is one of the most high-profile activists in the REIT industry. “What’s remarkable is it’s sitting there in the public market, and it’s a matter of how do you unlock it? If you can find a company that’s trading below its underlying asset value, that’s very hard to do in the private market.”

Indeed, some listed REITs currently are trading at discounts of 40 to 50 percent of their net asset value (NAV), according to Jonathan Morgan, deals analyst at Edge Consulting Group. “There are many publicly-traded REITs performing badly for various reasons, including portfolio quality,” he says. “A lot of them are pursuing flawed strategies and holding underperforming assets far longer than required.”

Activist boom

Morgan has observed “a lot more activism” in the REIT sector in the past year – typically taking the form of activist firms going after poorly-managed REITs and pushing for boardroom changes, or pursuing breakups of existing REITs and creating spinoff firms. Through such deals, activists hope to increase a company’s share price to better reflect what the former has determined to be the latter’s true underlying NAV. Fueling the recent activity is the firepower of activist investors, which have raised large amounts of capital and collectively increased their total assets under management by 33 percent to $112 billion from 2010 to 2014, according to Morgan.

A lot of that capital is going into REITs because of the relative ease of determining the underlying NAV of real estate companies as compared to those in other sectors, says Jim Sullivan, managing director at Newport Beach, California-based real estate research firm Green Street Advisors. “The reason is you have buildings trading all the time, and that tells you what things are worth.” Consequently, it’s easier in the REIT business for activists to identify companies that are trading below their intrinsic value, he says. 

Moreover, “we’ve seen some activists achieve success, which is emboldening other activists to look at REITs,” adds Sullivan. One such example was New York-based developer and fund manager Related Companies and hedge fund Corvex Management’s 2013/2014 activist deal involving CommonWealth REIT, where the two parties succeeded in removing the REIT’s existing board of directors and external manager, which the firms believed were hampering CommonWealth’s valuation as a company.  Shares of the REIT, which has been renamed Equity CommonWealth, were trading at $26.59 at press time, up from $15.85 in February 2013. 

That particular activist deal was a game changer in the REIT space, Sullivan notes. “There are some REIT ownership rules that create some obstacles that you don’t have in other industries to hostile suitors,” he says. “The success that activists had in CommonWealth have reset the guidelines how and when a hostile deal can be successful.”

Private interest

The discounts available in the REIT space have caught the attention of private equity real estate investors as the capital markets in private real estate have grown increasingly competitive. “I always try to look at where there is opportunity, where there is not a lot of capital or where it’s difficult for capital to go to,” says Edgar Alvarado, head of real estate equity at Allstate Investments, the investment arm of Northbrook, Illinois-based insurance company Allstate. Two years ago, he began seeing a potential opportunity in what he saw as a dislocation between public REITs and private real estate.

Alvarado and Litt, who have known each other for approximately 20 years, began exploring a possible activist transaction involving BRE Properties, a West Coast multifamily REIT. On the back of the potential deal, Alvarado put together a strategy that would involve Allstate partnering with Land and Buildings on activist deals in the REIT space, where the hedge fund would source potential transactions and Allstate would act as the capital provider. 

However, Allstate ultimately decided against pursuing an activist strategy in the REIT space. “It was something that was too complicated from an execution standpoint,” he says. 

Optic risk

Alvarado stresses that the strategy that he had originally discussed with Litt was strictly a management-friendly approach, where the two parties would work with a REIT’s senior executives to improve the underlying value of the company, not seek to replace its board or pursue a proxy contest. Shareholder activism, however, often has taken on a negative connotation because of its association with hostile takeovers.

“The part where it gets difficult for an institution is what I would call optic risk associated with activist strategies,” he says. “We’re a public company, do we want to see ourselves as being on the activist side in terms of going after what we consider mismanaged REITs?”

Meanwhile, Litt views activism as “any situation where we’re involved with management and engaged with them to discuss ways to maximize shareholder value.” He says that he tries to work with management on an amicable basis, and that the majority of the time, the senior executives at a REIT are receptive to ideas from their shareholders. 

This year, however, Land and Buildings has taken a more aggressive stance as an activist, and launched proxy campaigns to replace directors on the boards of Associated Estates; shopping mall REIT Macerich; and MGM Resorts International.

The activist/PE divide

Litt believes that most private institutions that are seeking to buy real estate only want to do so on a friendly basis with public companies. Such investors therefore will go after a REIT only when a company has been put up for sale.  “There’s very little appetite to do anything that’s perceived to be hostile,” he says.

Some private equity real estate firms aren’t interested in becoming activists in the REIT space, given that the two groups usually have different investment objectives. “The role of an activist is clamoring for change in the public sense,” says Sullivan. “Private equity shops do work behind the scenes.” However, private equity firms, such as Brookfield in the Associated Estates deal, “can be the beneficiary of activists stirring the pot.”

Activists, moreover, typically want the REITs to remain public, while private equity real estate firms seek to take those companies private. “I think the control issue is really what will drive private equity shops,” says Alvarado. “With an activist strategy, there’s a lot of rules and regulations that you’ve got to follow, and it’s not easy to battle management. So why battle management? It’s easier just to buy the whole company.”

Alvarado believes that the public REIT market is in the early stages of another cycle of merger and acquisitions activity, similar to the 2004 to 2007 period where there was a wave of M&A transactions – including those driven by private equity firms. Indeed, The Blackstone Group is said to be looking at deploying capital from its $15 billion global property fund in public-to-private transactions while Lone Star Funds reportedly is in advanced discussions to acquire Home Properties, a Rochester, New York-based apartment REIT.

In the years just prior to the crash, “private valuations were very high, and there was lots of competitive capital, and so people were starting to look at the public space as a way to put money to work and maybe unlock some discounts to real estate valuations,” he says. “It seems very similar to where we’re at today.”