November 21, 2006
A NEW DAY, A NEW DEAL
There are several theories about what keeps REITs flying. There's also a growing chorus of bears who warn that we're near a top for the asset class. But whatever your view, the news of a private-equity fund's unsolicited buyout offer on Sunday for Equity Office Properties (NYSE: EOP) offers one more reason to think that the game's not quite up in the long-running bull market for publicly traded real estate securities.
EOP, the largest REIT and one that's in the S&P 500, accepted a $36 billion buyout offer from an affiliate of the Blackstone Group, a New York private equity firm. Blackstone will acquire all the outstanding common stock of EOP at $48.50, or an 8.5% premium over last Friday's close.
The deal for the nation's largest office landlord raises eyebrows on a number of levels. For starters, it's reportedly the largest buyout package in history. The Wall Street Journal (subscription required) reported that the price tag "implies a 'cap rate', or rental yield, of about 6% -- well below the 10% at which real-estate investment trusts, or REITS, have historically traded." The article adds that the terms suggest that Blackstone is valuing EOP at a 17% premium to net asset value, according to analysis by Citigroup. "That's unusual -- even for Blackstone," the story advised. "It paid no more than 4% premiums to NAV when it acquired Trizec Properties and CarrAmerica. And even those were seen as pricy at the time."
Rich or not, the EOP deal is a sign of the times. Indeed, this year has witnessed a surge in mergers and acquisitions of REITs. Keven Lindemann, director of real estate for SNL Financial, told the New York Times today that 21 REITs in 2006 have announced that they're being bought by another REIT or private firm, and that more were probably coming.
No doubt that the buyers see value and opportunity. The sellers are feeling pretty good too. Sam Zell, EOP's founder, is reported to have said that Blackstone's deal to take his company private is "a validation of the public real estate markets. This suggests that REITs have become part of the overall capital markets. That's a very positive thing."
Positive, that is, for veteran shareholders who are selling. As for the validation of public markets, yes and no. True, EOP is being bought whole hog, a transaction that owes much to the firm's public listing. But in the process, EOP bids farewell to the public markets. Of course, in its remaining days as a publicly traded entity, the firm's record as a security is nothing if not impressive this year. As of last night's close, EOP shares were up more than 60% year to date. In fact, REITs generally have continued to soar. The Vanguard REIT ETF (AMEX: VNQ) is up 34% through yesterday, or more than double the S&P 500's 14.1% total return so far in 2006.
Although some critics say that EOP's deal is pricey, that's hardly a universal view. In the Times story noted above, James Corl, CIO of Cohen & Steers, a real estate-focused money manager that owns EOP shares, said the deal price for the stock represented a bargain for Blackstone. Corl cited rising office rents and bullish momentum for REITs in foreign markets. In addition, Barry Vinocur, editor of Realty Stock Review, told the Times that he's heard several real estate professionals say that Blackstone didn't overpay.
In any case, EOP's buyout reflects the fact that there's lots of money in the private-equity world--money that's looking for a home and appears, overall, to be chasing deals. Is this a seller's market? It's starting to look like one, and REITs are only the tip of the financial iceberg.
Private equity funding as a percentage of total M&As this year through October more than doubled to 18% from 8% in the same period in 2005, and from 3% in 2004, according to UBS numbers via the Sydney Morning Herald.
Indeed, investors are poring money into private equity funds at record rates. The fear of mediocre equity returns and relatively low bond yields are two reasons. Managers of private equity funds aren't asking questions, however, and instead are simply fulfilling their mandates by searching the world for fresh takeover material. A similar appetite can be found in corporations, which are also flush with cash thanks to rising profits that, as a share of the economy, are at 40-year highs.
"There's an enormous wall of money that has been raised...and that money needs to be invested," Ted Scott, director at F&C Asset Management, opined in Scotsman.com yesterday. What might end, or at least slow the private-equity money train? Perhaps if a deal fails on some level, Scott speculated. Meanwhile, full speed ahead, albeit with caveats. The deals increasingly "are becoming more risky and marginal gains are being made," Scott warned. "Some of the valuations are quite toppy, to say the least."
There are several signs supporting that claim. That includes a risk premium that's' barely worth the name in junk bonds relative to Treasuries. Consider that the spread in U.S. high yield bonds over U.S. governments is under 300 basis points, a thin margin of error that's historically low and fueled by strong gains in junk. Year to date, the Lehman Corporate High Yield Index has climbed 10.3% vs. 3.7% for U.S. Government/Credit, according to Lehman.com.
But it all looks appealing to private equity funds and corporations, which are funding buyouts with low-cost loans and investor monies desperate for higher returns. For now, no one's complaining. There's lots of money, and it's being put to work. Never mind that finding bargain-priced deals is getting harder by the day. The money will keep flowing until Mr. Market (or Ben Bernanke) yells stop. For the moment, however, there are only celebrations. Looking for historically healthy risk premiums, as a result, remains a thankless task.
Posted by jp at November 21, 2006 10:46 AM
I haven't seen the market, as a whole, rise so far on so little since the 2000 top. I don't know enough to try to commemt on EOP but the risk premiums are at or near all time lows. I have trouble justifing investment in this market, but I have been that way since January 2006. I'm not sure I've been wrong about the market as I have on the actions of the Fed. At some point, even a stopped clock is right.
Here's hoping I have been completely wrong and will continue to be completely wrong for the next 10 years. Inflation is probably better than a financial meltdown.
At the end of the last market cycle, wall street targeted the moribund utility companies, convincing them they needed to be in the energy trading business or could compete with ATT as ISP's. This time around, it's mining companies and real estate companies.
Posted by: zinc at November 24, 2006 8:59 AM