REITs ARE GOING LIKE A HOUSE AFIRE
A band of big-time real estate investors is sparking a wave of respectable IPOs
Mortimer B. Zuckerman doesn't shy from the public eye. The longtime bachelor's succession of relationships, as well as his recent wedding, have been well chronicled in the press. But when it comes to his vast real estate and publishing empire, Zuckerman has operated differently: "I never wanted to bring any of my companies public," he says. But soon, Zuckerman will float the biggest real estate investment trust offering in history, a $903 million initial public stock offering of Boston Properties, a collection of trophy office buildings.
Zuckerman's IPO is only one of several high-profile REITs likely to hit the market soon. Chicago real estate magnate Sam Zell intends to sell about 10% of his $5 billion portfolio of office towers, and real estate moguls from Donald L. Bren in Irvine, Calif., to New York's Stephen L. Green are said to be considering taking their empires public. Add that to the more than $1 billion in REIT IPOs and more than $8 billion in REIT secondary offerings thus far in 1997, and it should be the biggest year for REIT offerings since 1993. (REITs are companies whose assets are pools of actively managed real estate or mortgages. REITs pay out most of their profits in dividends and are exempt from corporate taxation.)
Issuers are jumping onto the tail of the hottest REIT market in years. Even after a first-quarter correction, REITs are up 29% over the last 12 months, compared with 25% for the Standard & Poor's 500-stock index. And many public REITs are now selling at a 20% premium to the value of their underlying properties, so not only do they have better access to capital but they have a major advantage over private real estate companies in buying more properties.
SPOTTY PAST. This latest wave of REIT IPOs and secondary offerings is giving the REIT industry much greater legitimacy. "Real estate is finally becoming more like every other American major industry--publicly traded and accessible to all investors. And REITs are the vehicle of change," says Mike Kirby, co-founder and principal of real estate research firm Green Street Advisors Inc. In the past, far too many REIT IPOs were exit strategies launched by troubled companies that went public to avoid going broke after traditional wells of financing had run dry. The market was too small and spotty to gain a big analytical following. Now, however, REITs are the preferred way to invest in real estate. "They are real operating companies that lease, renovate, manage, tear down, rebuild, and develop from scratch," says Stan Ross, managing partner of E&Y Kenneth Leventhal Real Estate Group.
Strong support for the REIT market comes from institutional investors, who are major REIT buyers for the first time. There are now more than 25 REITs with market values of more than $1 billion, a substantial enough size for institutions to buy or sell shares without upsetting the REIT's price. Many of these REITs are run by the savviest investors in the industry, such as Richard E. Rainwater, William D. Sanders, and Steven Roth. With commercial real estate prices almost fully recovered from their 1991-1992 lows, "the big investment opportunity for us now is the recapitalization and consolidation of the industry by this band of elite REITs," says Joseph M. Harvey, director of research at leading REIT mutual-fund firm Cohen & Steers Capital Management. In 1997 alone, institutional investors are expected to swap about $7 billion of directly held real estate for stakes in REITs. "We absolutely plan on being a consolidator across all REIT sectors," says Zell, who has two other big REITs.
In the last REIT IPO wave, in 1993, fee-hungry investment bankers helped launch many REITs of questionable quality. One structure dreamed up by Wall Street, called the "umbrella REIT," or UPREIT, brought many of the most prominent real estate companies public but also enabled some dogs to enter the market. To form an UPREIT, real estate partnerships pool properties, exchanging individual units for a share in a larger partnership, and then issue a REIT, which purchases units in the partnership. Since the partners avoid selling properties, they postpone paying taxes on capital gains. But if those properties are sold, the partners will incur capital gains.
Zuckerman's REIT adds a twist to the UPREIT structure. If any of the properties transferred into his new REIT are sold, all shareholders, rather than just the operating partners, will bear all the capital-gains penalties. Harvey says that while Zuckerman has several of the "highest cash-producing office buildings in the country," the REIT's structure should adversely impact the value of the company.
Zell says that Wall Street is looking at the REIT industry more critically than in the past. Case in point: a $460 million IPO registration by Australian billionaire Frank Lowy's Los Angeles-based Westfield America Inc., an owner of malls that subcontracts management to an outside adviser. Green Street Advisors issued a report objecting to that, since Lowy had a percentage of both the REIT and the adviser that would be paid management fees by the REIT. The deal is now being restructured and repriced. Lowy has upped his ownership stake in the REIT, which aligns his interests more closely with the REIT, and the IPO has been valued at $315 million.
BIG NAMES. With all the big names jumping into the ring, one thing is clear: The easy money has been made in REITs. It will be tough to beat the 35.8% return on The National Association of Real Estate Investment Trust's REIT index in 1996 or the index's 18.3% gain in 1995. Through Apr. 30, the index was down 2%. Investor demand remains strong: The average monthly flow into REIT mutual funds, as of Apr. 30, was about $520 million, compared with average inflows of $68 million for the same period in 1996.
If the Zuckerman IPO proves a hit, as many experts predict, then going public could be as welcome a change for him as getting married.By Kathleen Morris in Los Angeles, with Richard A. Melcher in ChicagoReturn to top