If You Must Own REITs...
To the lengthening list of reasons to distrust real estate securities, please allow me to add one more: merger and acquisition (M&A) activity is picking up in the REIT sector.
Shortly after M&A activity in a given industry heats up, the industry often becomes stone cold. …especially if the acquirers are paying for their acquisitions with stock instead of cash.
I had this very thought in mind when I urged the subscribers of my Fleet Street Letter to take profits on Catellus, which ProLogis recently acquired. REITs have enjoyed an amazing five-year run, as the chart below clearly illustrates. The MSCI REIT Index has more than doubled since 2000, compared to break-even or negative returns from the broader market indexes.
Not surprisingly, therefore, M&A activity has picked up dramatically. Last year, for example, there were 14 REIT acquisitions, worth a total of nearly $20 billion. So far in 2005, the blistering pace continues, with seven transactions pending or completed. The acquisitions continue, despite that fact that few values remain in the REIT sector.
Keven Lindemann, director of real estate research at SNL Financial, points out that almost all of the 128 publicly traded REITs he follows carry very rich valuations. Of these publicly traded REITs, only 17 trade at a discount to their net asset value (or NAV, which represents an estimate of the value of the underlying real estate a REIT owns). And of these 17, only five of them sell for more than 10% below their NAVs. The nearby chart presents this select group.
On a net asset value basis, these are the cheapest REITS on the market. When I recommended Catellus, it was trading at a discount to my estimate of its NAV. ProLogis acquired it within eight months. Similarly, these REITS would seem to be good candidates for acquisition. If you must own REITS, this is as a good list to start your research with as any.
Keep in mind that in the REIT world, hostile takeovers are rare. That’s because insiders often own a good chunk of stock and can block acquisitions they don’t support. Most REIT acquisitions happen with the aid of willing management and an amenable board of directors.
It’s interesting to note that the NAV discounts themselves do not appear all that large. There are only two companies in the table above with a discount larger than 20%. On the flip side, many REITS trade at substantial premiums to NAV. Below is a table that compiles the REITS with premiums to NAV of at least 35%:
Unfortunately, the values available in the REIT sector aren’t quite as fresh as they used to be…or ought to be.
WTI NYMEX CRUDE