REIT Rebound Spells Opportunity

Want to do business with real estate investment trusts? Local expertise and international investor contacts are your best route in.

July 1, 1999

Those heady days when real estate investment trusts seemed to be gobbling up every apartment building, office complex, and retail center in sight have become a distant memory since their stock prices plunged last year. But that hasn’t stopped practitioners from working on a steady stream of REIT deals.

REIT fortunes came crashing down about 18 months ago when investors, fearful of widespread overbuilding, rising interest rates, and overpriced acquisitions, pulled their money out of the publicly traded real estate companies. Since then, their stock prices have begun to see modest increases in value, but for most of 1998 they trailed woefully below other stock sectors, which have been riding the market to record levels.

Despite their recent problems, REITs are here for the long term and will always be in the market for the right property, say commercial practitioners who work with them. Some sellers continue to find it attractive to exchange their properties for trust shares in what’s known as “UPREIT” transactions; some REITs have begun aggressively seeking joint venture partners to develop, acquire, or take their equity out of properties; and buyers are on the hunt for REITs looking to shed properties that no longer fit their portfolios.

Many of the trusts are also upping their use of local practitioners to oversee initial and ongoing leasing even as most continue to consolidate project management activities in-house.

All these types of transactions spell opportunity for practitioners who know how REITs operate, have experience negotiating transactions unique to REITs, and have contacts among investors looking for real estate deals. But even if you haven’t worked much with REITs, you could be doing business with them if you know the dynamics of your local market and a particular commercial product type.

“The main thing practitioners sell is their knowledge of the market area and their product expertise,” says Cynthia Shelton, CCIM, vice president of acquisitions for Commercial Net Lease Realty, an office and retail REIT headquartered in Orlando, Fla.

Local market expertise becomes especially critical as REITs branch out from their operating bases and acquire properties in unfamiliar areas, something REITs are doing more as they search out opportunities to spur growth. “As we move into new markets, we cooperate with local practitioners quite a bit,” says Amy Tait, executive vice president of Home Properties in Rochester, N.Y., a multifamily housing trust.

Although market knowledge is the indispensable base from which to begin your marketing outreach to buyers and sellers, it’s not sufficient by itself to grab the attention of REITs. Taxes are at the heart of many REIT transactions, and that means you must know enough about the advantages and disadvantages of working with these companies to be able to identify property owners who could benefit from the tax advantages of selling to a REIT.

The REIT way and the wrong way

Fueling much of the growth of REITs, especially in the mid-1990s when their stocks were riding high, are UPREIT transactions whereby sellers avoid deal-killing tax liability by handing over their property to a trust in exchange for shares of REIT stock instead of cash.

The transaction is not unlike a 1031 tax-deferred exchange in that the seller avoids tax liability by plowing the proceeds from the sale back into real estate. But unlike 1031 exchanges, UPREIT transactions don’t require sellers to remain hands-on property owners. That feature makes them attractive deals for owners who see 1031 exchanges as nothing more than the exchange of one set of real estate headaches for another. Not only do sellers get out of the day-to-day concerns of real estate ownership, but they also minimize up-and-down project performance by spreading their risks among the REIT’s large, diversified portfolio.

The name “UPREIT” comes from the character of the ownership structure. The seller trades the property in exchange for shares in the umbrella partnership--the UPREIT--that owns a controlling interest in the REIT.

The attractiveness of selling to a REIT in an UPREIT transaction would appear to rise and fall with the attractiveness of owning the REIT’s stock, but practitioners say it depends on the investment strategy of the property owner. Joseph Verdejo, senior managing director of Insignia-ESG in Philadelphia, says that sellers should grab on to as many shares as they can while the stock prices are undervalued.

“It’s a factor of your confidence in the particular REIT and the industry in general,” he says. “If you think its shares are undervalued, now is a good time to accumulate the REIT’s stocks.”

That will be a hard sell to property owners who are bearish on the value of holding REIT stock. That’s why Garry Weiss, principal of Podolsky Northstar Realty Partners in Westchester, Ill., hasn’t spent much time during the past year trying to sell that strategy to investors. After handling about $800 million in UPREIT transactions in the mid-1990s, Weiss found more lucrative business pairing REITs up with investors in joint venture deals. The last UPREIT transaction he worked on was a $41 million office deal that closed in June 1998.

“When investors got out of the market, a lot of REITs started looking for other ways to do deals, since they couldn’t raise the capital on Wall Street,” says Weiss.

Joint ventures enable REITs, while their stock prices remain low, to use the capital of their partners to keep their acquisition (and, increasingly, development) pipeline full. Unlike conventional real estate companies, REITs face restrictions on the amount of debt they can assume, making it difficult for them to continue growing when Wall Street dries up as a source of capital. The advantage to the investment partners is the same as it is for the Wall Street investors: They get the trust’s real estate expertise.

Weiss has been in Europe several times over the past few years talking with foreign investors who are eager to invest in U.S. real estate but who don’t want to make the upfront investment in staff and research to compete head-to-head with REITs in the acquisition market. Because of tax law changes in Germany, investors in that country have become a particularly rich source of joint venture prospects, says Weiss. He relies heavily on his association with CORFAC, an international corporate facilities network of which he’s a member, to set up meetings with foreign investors. NAR offers similar opportunities to meet international clients through its Certified International Property Specialist (CIPS) network.

In a typical joint venture arrangement, the REIT will cash out its equity in an existing asset by bringing in an investment partner to acquire a large chunk, say 85 percent, of the property’s operating partnership. The company uses the capital infusion to pay off the old debt and fund new acquisitions, which enables the REIT to generate new value for shareholders out of a mature asset. The company continues to act as the general partner in the project operating partnership and retains property and asset management fees.

The arrangement works basically the same for acquisitions or new development projects.

“Foreign investors want to do joint ventures with REITs,” Weiss says. “After getting an arrow in our quiver by learning how to do UPREIT transactions, we’re now starting to get sophisticated on these joint venture deals.”

The REIT stuff

REITs have always preferred to consolidate project management in-house because of the operating efficiencies that creates, and that preference has become more firmly entrenched now that their capital source has become constrained. That doesn’t bode well for practitioners who specialize in commercial property management, but opportunities still exist, primarily for leasing specialists.

“Property management is a lot more transferable than leasing, so you can expect REITs, when they move into a new area, to bring in their own management,” says Robert Bryan, CCIM, CPM®, of LaSalle Partners Management Services in Orlando, Fla. “But because leasing takes particular local expertise, these companies will often outsource that function. If you have local expertise, you are going to know who’s looking for space and expose the property to the right prospects.”

Bryan’s company in late 1997 landed a contract to oversee initial leasing and initial project management of Miami Center, Miami’s second tallest building, from Atlanta-based REIT Crescent Real Estate Equities. Because of its local marketing expertise, LaSalle was retained to oversee ongoing leasing--even as Crescent, six months after it acquired the building, assumed project management.

“The building had had leasing problems in the past, so we went to Crescent with a new marketing program,” says Bryan. “We’ve since been able to bring the building up to a vacancy rate that’s proportionate to the area.”

One key to winning leasing contracts is to help REITs with their acquisitions. “You want to put yourself in a position to bring them properties they otherwise wouldn’t see,” says Bryan. “Because a lot of them haven’t been around a long time, REITs aren’t tied to broker relations in the way that a lot of institutional investors are. If you can bring them an acquisition, you can use that to get your management and leasing expertise in front of them.”

Robert Freedman

Robert Freedman is the former director of multimedia communications at NAR.

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