A few eyebrows may have been raised at the end of July when Lone Star Funds announced its bid to buy London-listed property developer Quintain Estates and Development for around £700 million (€988 million; $1.1 billion).
The Dallas-based real estate investment manager bid 131 pence per share, which was a premium of approximately 22.4 percent to the prior day’s closing price of 107 pence. The bid also represented a 7.4 percent premium to Quintain’s net asset value at the end of March.
Yet, despite being a premium price on paper, the bid did not appear overly generous, analysts said.
“Quintain has traded at a valuation discount to the sector for an extended period of time as current management has sought to de-lever the balance sheet and focus on the development opportunity at Wembley,” David Brockton, real estate analyst at Liberum Capital, said.
Quintain neared bankruptcy after the financial crisis, with its share price falling from 450 pence in 2007 to 4 pence in 2009. In response, a new management team started work on reducing its gearing, which was down to 32 percent in March from 87 percent in March 2012.
Yet, the big draw for Lone Star is Quintain’s development of the Wembley Park area. “This is an opportunity to acquire a unique residential development scheme in London, with strong existing transportation links, and where its mid-price offering could have a big PRS [private rented sector] angle to it. The development profits that could accrue to Quintain from delivering Wembley are not fully factored into the valuation, and the longer term institutional value of PRS could provide even greater upside,” Brockton added.
With its takeover of Quintain, Lone Star is betting on the London property market and in particular, Wembley Park. Quintain is currently developing residential property in that area of London, with the Wembley development making up 77 percent of its asset exposure as of March. Of the developer’s total assets, Wembley investment assets represent 33 percent, while development land makes up 42 percent, according to the Quintain investor presentations. Outside of Wembley, Quintain’s London investment portfolio accounts for 11 percent of its overall assets.
Quintain already has detailed consent for building out 5,500 homes on 40 acres and therefore would face no planning hurdles with its project. The development also serves a well-publicized structural shortage of mid-mainstream housing in the city, in contrast to some other developers that are focusing on higher-end housing in London.
Indeed, the shortfall in London housing is not in the £2000 per-square-foot segment of the market, but rather the £1000 per-square-foot-or-less segment, also known as mid-market housing, according to a source familiar with Lone Star’s bid.
Market sources suggest that Lone Star is not the only opportunistic real estate investor which sees value in public development plays.
“What you are seeing globally, and especially in London, is that the acquisition markets in real estate are so competitive, with yields down to record-low levels and return figures that just don’t work for certain types of buyers,” said Ryan Dobratz, portfolio manager at Third Avenue Management, which is a substantial shareholder in Quintain. “Investors who require higher than a core yield look to other types of real estate investment and increasingly are looking at development plays.”
Dobratz expects that M&A activity should continue to accelerate in the US and the UK for companies with strong development pipelines. He noted other listed real estate companies as potential targets and added that some fund managers might feel pressured to play the public markets after raising very large funds. “It’s hard to put that type of capital to work without looking to some of these larger portfolios and platforms that are in the public markets.”
Yet, not everyone shares Dobratz’s view. A source close to Lone Star’s bid said the Quintain opportunity is particularly unique: “That the stock market undervalues development plays is a fact. Are there that many more out there to do? I’m not so sure. There aren’t many big London regeneration projects still to be done and one near the iconic venue of Wembley Stadium is really strong.”
Lone Star certainly has previous experience in taking private large residential players. Only in June did the firm agree to take over US REIT, Home Properties, for $7.6 billion. It looks like Lone Star has found a practical answer to having a lot of capital and a lack of classic distressed real estate in both the US and the UK.