The private real estate industry is on track for a record year of mergers and acquisitions.
With 16 transactions closed thus far, M&A activity is up 45 percent year-on-year and poised to surpass 2018’s record of 26 deals, according to a mid-year market report compiled by the New York-based advisory Hodes Weill & Associates.
The report, viewed exclusively by PERE, attributes this deluge to pent-up demand coming out of lockdown-hampered 2020, rising valuations, the long-running trend toward consolidation and even concerns about changes to the US tax code.
Based on the number of known deals in process, Hodes Weill managing partner Doug Weill told PERE he believes 2021 will stand alone in the M&A record books. “We feel pretty confident that this is going to be the most active year that we have seen across the board,” he said.
A flurry of activity
Notable deals thus far include Ares Management buying Black Creek Group; EQT’s purchase of Exeter Property; Oxford’s acquisition of M7 Real Estate, The Carlyle Group’s sale of Metropolitan Real Estate to BentallGreenOak; and USAA Real Estate crystalizing its acquisition of Square Mile Capital by securing the last remaining interest in the firm. Some of these have been in the works since last year or earlier, Weill said, and were delayed by world events, but he attributed most of the activity to current market dynamics.
Through the first two quarters of 2021, closed-end funds have accounted for $62 billion of closings across 107 funds, according to PERE data, putting the market on track for its worst year in a decade. But Weill said robust fundraising for open-end vehicles and separately managed accounts has continued to drive growth in the sector. “If you look at the largest managers across alternatives, their real estate portfolios are benefiting from tailwinds with double-digit AUM growth driven by strong performance and increasing allocations from institutional and retail clients,” he said.
Growth by acquisition
For large, diversified managers looking to add exposure to in-demand sectors and geographies, mergers and acquisitions have proven to be more effective strategies than building platforms from scratch. EQT and Ares both did this by purchasing logistics specialists Exeter and Black Creek, respectively. Blackstone bought back into the single-family rental space by acquiring Home Partners of America and Brookfield nabbed a land banking platform with its acquisition of Newland.
“For managers that have a footprint in real estate, this type of M&A accelerates their growth and fills in gaps in their platforms,” Weill said.
Half the deals in 2021 thus far have been 100 percent sales, according to the report, up from 17 percent in 2020. Meanwhile, minority stake sales, the favored strategy last year with 56 percent of dealflow, have accounted for 38 percent of the market in this year.
Listed managers have the added advantage of appreciated stock prices, Hodes Weill managing partner David Hodes told PERE, which gives them additional currency for acquiring publicly traded platforms. On average, stock for such managers has appreciated 33.5 percent year-on-year and trades at an EBITDA multiple of 20.3x. This means acquirers have more capital at their disposal and acquisition targets, even those who had previously resisted buyout overtures, are suddenly getting offers that are too good to refuse.
“Many of the remaining independent managers have gotten calls year after year after year about doing something with their platform,” Hodes said. “Many of them pushed it off, didn’t really want to think about it but as we’re getting to levels of pricing they probably did not expect, they’re not pushing off suitors as aggressively.”
Another factor that has driven M&A activity in 2021 is the concern that the Biden administration will usher in changes to the US tax code that will make future deals less favorable for sellers. Specifically, the threat of a higher capital gains tax rate has caused owners who were considering a sale in the near term to accelerate that activity to this year, before any potential changes go into effect.
Despite controlling both legislative bodies and the White House, the Democrat-led government has struggled to pass even broadly supported legislation for pandemic relief, voting rights and infrastructure. Still, Hodes said raising the capital gains tax rate – currently capped at 20 percent, well below the top income tax rate of 37 percent – has been viewed as an inevitability.
“Whereas ending the tax shelter on carried interests versus taxing these profits as ordinary income is controversial, the 2017 tax changes may have overshot by reducing the capital gains tax level to current levels,” Hodes said. “So, this is one of the potential changes in the tax code the industry is taking more seriously.”
Groups started factoring in the implications of a higher future tax rate during the second quarter of 2020, Hodes said, adding that it could be an M&A driver during the second half of the year. “Many managers are thinking that their after-tax proceeds could be better in 2021. This could create quite a bit of activity between now and year-end.”