Why wouldn't a fund do a leveraged buyout of an undervalued REIT?

The market cap of my publicly traded REIT is trading (and has been for a while) at about $5B less than our assets are worth. What's more, we are highly UNleveraged. I'm confused why a larger fund hasn't bought us out yet... it seems like it would be so easy to lever up, sell all the assets, liquidate the company, and come away $10B richer. I know it's more complicated than that, but still. I don't think my REIT is alone in being so undervalued. I'm just curious why companies don't buyout undervalued REITs more.

Comments (18)

Mar 29, 2018

Well, there are a couple of reasons I can think of. I'm not an expert on REIT tax law, but I know enough to be dangerous and I'm pretty sure that the only way they qualify for the tax benefit is they have to disburse 95% of the cash flows and there's some rule where a certain individual/entity can't own more than x% of the operating interest in the REIT. So those two attributes will scare off a lot of the players capable of putting down that much cash since it is very difficult to take a REIT private by way of legal proceedings and $ since you get screwed from a tax perspective, or so I've been told.

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Mar 29, 2018

90%* FIFY

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Mar 30, 2018

Oh ok, thanks for the assist. Did that change recently or has that always been the case?

Best Response
Mar 29, 2018

@MonkeyWrench hit it right on the head. REITs must be owned by at least 100 people and 50% of the fund cannot be held by 5 or fewer people. This is a big deal because that kills the REIT status. No large investor will buy out an asset that has a regulation like that in place.

Second, REITs are subject to disbursement requirements (spot on with the 95% of cash flow call. The rule is that at least 90% needs to be distributed from Funds From Operations - essentially Net Income +D&A + Gains/Losses on Sale of Property - to qualify for a REIT provided they meet other criteria). Assuming that an LBO fund could buy a REIT and ignore rule number one, the question becomes how do they pay the debt down. As a result of rule the disbursement issue, traditional aspects of the LBO process, such as paying down debt with excess cash, don't work as readily here since the excess cash must be distributed to shareholders. Since the fund disbursement is key, how exactly would the fund pay down the debt at an accelerated rate? It wouldn't be able to.

The only way it could possibly work is if you had enough funds come together to buy out the REIT and divide the ownership in such a way that it could retain its REIT status. That becomes a very sticky thing to do and is definitely not an ideal situation.

Mar 29, 2018

Maybe someone from a megafund who has done this can chime in: do buyers generally maintain the REIT structure when taking a public REIT private? If so - I don't believe that each fund counts as an individual for the 100 owner requirement; how far down the ownership structure can you go to find "individual" owners? (IE: does a pension fund LP count as and individual or are each of the thousands of beneficiaries individuals?)

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Mar 29, 2018

Great question - often wonder about this too. Couple of thoughts:
Most REITs are incorporated in Maryland where it is prohibitively difficult to execute an unfriendly takeover. (Check out MUTA if you want to dig in further).
I think that the other aspect is because of what you mentioned above. Owning hard assets, allows everyone (not just Blackstone/Lonestar, etc) to know how much your company is "worth" outside of just relying on market cap. This means that shareholders are not likely to agree to a sale at a substantial discount to what they believe the value is (regardless of where the stock is trading).
It can be very frustrating to trade below NAV from the REITs perspective, though, since the increased cost of capital makes it harder to expand. And this can lead to management looking to a friendly takeover after extended periods of under-performance. I think this is generally when you will see these takeovers happen. Lot of expensive examples of failed unfriendly takeovers in REIT industry,

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Mar 29, 2018

What are common reasons why a REIT trades below NAV in the first place?

Mar 29, 2018

I think GGP is a good example. We can all come up with a good estimate of NAV based on what we think the private market value of their RE is, but your estimate is only as good as your comps (class-A fortress malls are an extreme examples where there are very few trades). There is a lot of concern about the future of retail in today's environment and that is going to be reflected in stock prices long before it is reflected in private market trades - no way in hell Macerich or Simon are going to start unloading well-located A-malls at 6 caps now that the GGP comp is out there.

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Mar 29, 2018

Very well put.

Adding to this, a REIT may have a portfolio of properties that are all showing strong operating fundamentals, growing NOI, high occupancy, etc. that, when taken together, add up to high valuations. If you were to sell this hypothetical REIT's assets today, you'd fetch high prices and high returns that justify a high stock price.

But REITs are public, and the market is pricing in today what it thinks REITs will be able to achieve in the future. With rising interest rates, weakness in retail, and the current length of the economic expansion, the market is saying "REITs have done really well but won't do quite as well in the coming months/quarters/years." And that's reflected in stock prices for certain REITs that are 10-15% below NAV.

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Mar 30, 2018

Such awesome insight- thanks guys. I guess it probably boils down to a mixture of everything above, topped off with a big capital gains tax if they were to sell the assets outside of REIT status.

Apr 1, 2018

It actually isn't as hard to take a REIT private if you have the cash.

Take CPP-IB's buyout of Parkway Properties last year. As far as I know it wasn't a leveraged buyout, but that is just a financing decision vs. the decision to take a company private.

Blackstone took Biomed private back in 2016.

All of the rules for a REIT are easy to bypass. There are literally hundreds of private REITs that do it.

The 100 owner rules is bypassed by creating a preferred shareholder class where each individual investor puts in 1000 and gets a return of ~10%. The rest of the shares are owned by your main investor.

The 5/50 rule is harder, but the 5/50 is actually a pass through requirement to individual investors. If your company is public, that ownership flows through, so as long as not more than 5 owners own more than 50% of your parent company, then you pass. For a pension firm or mutual fund, it goes down to the investor level, so to the 10,000 participants in your fund.

The reason I think you aren't seeing as many happen right now is because people feel like it is the top of the market and everyone would want a premium for the buyout. See, Brookfield's buyout of GGP.

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Apr 3, 2018

This guy knows what he is talking about. All that other noise posted above is garbage.

You can take a REIT private pretty easily if you have the cash to do. Furthermore OP, you are basically stating that the public markets are not valuing REITs the same way private markets would (thus the huge trading discount to NAV).

Another way a REIT can basically "sell" itself in the private markets without an LBO and realize value is via a plan of liquidation and then entering into a liquidating trust. This get pretty detailed and there are rules for timing, disclosure etc. so if you have questions, shoot me a PM.

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Apr 3, 2018

Also Brookfield / GGP was actually not a significant premium. Don't trust the news articles, Bfield does this every time owns 1/3 of a company then sends out an unsolicited offer that is a tad too low and then "boom" hits the nail on the head with a "premium" final offer. See Brookfield/Rouse, Brookfield/BOP, Brookfield/Associated Estates, etc

Apr 3, 2018

Maybe the underlying assets are overvalued and the market believes that the REIT value is more reflective of fundamental value?

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Mar 21, 2019
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