STATESIDE: Shooting for REITs

So the jungle drums beating back in April were correct: Lone Star Funds was indeed putting together a bid to take private Home Properties for $7.6 billion, as tipped by The REIT Newshound.

For on Monday, June 22, Home Properties announced a definitive agreement to sell had been reached with Dallas-based Lone Star, and save for a last minute counter-bid, there is every reason to suppose a deal will be completed.

The transaction is symptomatic of how opportunity funds are dealing with the current US market. There is no longer the slew of classic, distressed real estate opportunities that there used to be. Instead, private equity real estate firms with large amounts of capital are turning to corporate acquisitions and rolling up assets in sector-specific plays.

The US REIT industry is big nowadays. There is something like $1 trillion of assets managed via these vehicles, whereas 20 years ago their market cap was under $100 billion. That is one reason why they are attracting the attention of the likes of Lone Star. In the case of Home Properties, it has an $8 billion portfolio of 121 apartment communities containing 41,917 flats in New York, Florida, New Jersey, Virginia, Illinois, Maine, Massachusetts and Pennsylvania. 

Size is one reason. The second is that they are also extremely visible and transparent given their public nature, which helps when it comes to valuing the portfolio, and the enterprise, and ultimately pricing a bid. Plus some REITs have been trading at a significant discount to net asset value. In the case of Home Properties, it has been trading at a 4.5 percent discount.

Logic would dictate that Lone Star has surveyed the deal pipeline in the US and surmised that public property companies are a way to go in the absence of large pure distressed or opportunistic deals.

It has also plainly identified a sector it likes in multifamily and is pursuing the classic private equity strategy to build a platform in it. 

Last year, the signs were there. Lone Star bought 64 properties comprising 20,439 apartments for $1.8 billion from DRA Advisors and Bell Partners, and since then it is reasonable to assume it has been running the rule over REITs that might be used as a platform to roll up more assets in a larger, more efficient company. Home Properties fits the bill nicely in that it is large and there is no geographic overlap in terms of the portfolio. 

At the same time there is growth potential. Around 30 percent of Home Properties’ portfolio is in the greater Washington DC area, in places such as Alexandria, where evidence is mounting that apartment fundamentals are bottoming, particularly for for class-B assets as the local jobs market recovers. 

What is a little harder to work out is how much Lone Star should be paying for Home Properties. The REIT’s board obviously feels it is a fairly full offer or else it would not have recommended the bid. Indeed, the offer of $75.23 per share represents a premium of 11 percent above the share price for 60 days to April 24. In fact, the share price has not once reached more than $70 in the whole time between 2008 and the end of 2014. It has mainly been in the $50s and $60s in all that time, which underscores a common perception that buyers of REITs might be noting discounts to NAV, but will have to pay up fully for them. At least Lone Star is not paying the $82-a-share that analyst Green Street Advisors predicted when the rumor first surfaced back in April that Lone Star might bid.

This is certainly no hostile takeover. One could characterize the deal as a sale by a motivated seller. According to analyst notes, Home Properties requires significantly more capital than its peers in order to keep its ageing portfolio competitive. Home Properties’ average asset age is 35 years versus 20 years for rival REITs. That expenditure can become a burden. Plus, the leadership of the REIT is mature to say the least. The chief executive officer, Ed Pettinella, is energetic, but he is 63. Its eight executive officers average 59, and there is no obvious succession plan. 

A lack of succession plan can be a good motivator for change as shareholders don’t like it. Plus, the original founders have stepped back and steps have also been taken to simplify the strategy as it was anything but simple. For one thing, Home Properties went into development, but in 2014 reversed that decision. It had also toyed with the idea of going into the southeast US market, but in the end ditched that idea too. 

So there were signs that this was a company needing a new lease of life, and as things stand that new life seems to be in private hands with Lone Star.