Despite some signs of recovery in recent months, the U.S. real estate market remains soft. For example, housing starts increased in 2012 from 2011, but just barely, with the difference being only a mere 300 or so more new residential construction projects. Home sales actually fell 7.3 percent in December from November, according to the U.S. Department of Commerce, and they were worth only about half what they were before the housing market crashed in 2008. But, while these may not be encouraging signs for home owners or real estate brokers, they add up to opportunities for investors, who are eyeing multifamily homes and some types of commercial properties, including nursing homes and shopping centers, with particular glee. Private equity firms, Real Estate Investment Trusts (REITs) and strategic buyers are all taking advantage of the depressed state of the real estate market to gobble up properties, with the pace of dealmaking accelerating quickly.
"Since January, there has been an avalanche of capital and a stampede of players into the market who had been on the sidelines licking their wounds from deals done in 2007," says Matt Galligan, president of CIT Real Estate Finance.
CIT wanted in on the action as well. The firm launched a commercial real estate business in the fourth quarter of 2011. The group focuses on originating and underwriting senior secured commercial real estate loan transactions primarily in Boston, New York and Washington, D.C. In 2012, the firm closed on 21 loans, including a $25 million senior secured loan for National Resources, a real estate and investment firm focused on redeveloping corporate and industrial sites. The financing was used to develop The Lofts at Edgewater Harbor, a 150-unit residential condominium complex in Edgewater, N.J., overlooking the Hudson River. In January, CIT arranged a first-lien term loan for Kushner Companies, a real estate company headquartered in New York, and a $26 million senior secured term loan for Metropolitan Properties of America, a real estate investment firm based in Boston.
Private equity firms have shown a strong appetite for the sector as well. In fact, 156 private equity real estate funds raised $71.5 billion during 2012, which is on target with what was raised the year before, according to Private Equity Real Estate (PERE), a publication that covers the real estate market. More telling, opportunity funds, which specifically look to take advantage of falling real estate prices, raised $35 billion in 2012, a 45 percent increase from 2011. The Blackstone Group LP (NYSE: BX) raised the largest real estate opportunity vehicle during 2012, helping to push the real estate fund numbers up. Blackstone Real Estate Partners VII raised a whopping $13.3 billion.
Private equity firms obviously think there are more deals to be made. There are an additional 585 private equity real estate funds in the market and they are targeting a total of $209 billion, according to PERE. That said, there are a few firms that were active in the space and are now notably missing. Morgan Stanley (NYSE: MS) and Goldman Sachs (NYSE: GS) are not nearly as active as they were prior to the downturn. In fact, Whitehall Street International, the real estate investment fund that Goldman Sachs invested through, lost more than $1.76 billion in real estate in 2009.
This leaves room for other firms to get in action, but they aren't all large players. For example, in January, The Meridian Group, a real estate firm based in Bethesda, Md., closed a new fund with $160 million, while Westport Capital Partners raised a $963 million fund that closed in 2012.
The reason for all of the fundraising is simple: There are plenty of deals out there for the taking. Private equity firms such as TPG Capital, The Carlyle Group (Nasdaq: CG), The Blackstone Group, H.I.G. Capital and Westport Capital Partners have been very busy taking advantage of the opportunities.
"There is a fair amount of trading going on, but success depends on what level of risk an investor is willing to take on," says Russ Bernard, a managing principal with Westport Capital Partners. "I don't consider the real estate market to be at its healthiest, but that doesn't mean it isn't a great time to invest if you know what you are doing - some buyers will make a good return on their investment."
Shortly after closing its new fund, Meridian turned around and bought up more than half a million square feet of office space in Northern Virginia, including the 280,000-square-foot Tysons Technology Center. In November 2012, Westport purchased Marketfair Mall, a 250,000-square-foot retail complex in Fayetteville, N.C. In January, Blackstone, which boasts the largest real estate portfolio in the world, paid $2.5 billion for 16,000 single-family homes that the firm plans to manage as rental properties. Also in January, with a $2.3 billion fund raised in 2011, Carlyle acquired Monarch Place Piedmont, a 149-unit assisted living community in Oakland, Calif. Carlyle is planning a $1.5 million renovation of the property.
"Private equity firms have a lot of money, and real estate has the benefit of good relative value. Capitalization rates would traditionally be 300 basis points over Treasuries; today they are 400 to 500 over Treasuries, so there's a nice cushion there," says Galligan.
Private equity real estate firms aren't the only investors that have been active in the market. REITs have been as busy as ever. Listed REITs raised a record amount of capital-$73.3 billion-from the public markets in 2012, surpassing the previous record of $51.3 billion raised in 2011, according to the National Association of Real Estate Investment Trusts. "REITs have been raising capital for the past two years and they have used the equity to reduce debt on balance sheets and they have been buying up properties in a big way," says David Lowery, co-head of real estate at Jones Day. "They are expecting the market to recover and are taking advantage of the opportunities now."
REITs, which are essentially any corporation, trust or association that acts as an investment agent specializing in real estate, have definitely been busy. Consider this: During 2012, Aviv REIT Inc., which specializes in buying and operating post-acute and long-term care skilled nursing facilities, and Phillips Edison-ARC Shopping Center REIT Inc. were two of the most acquisitive real estate groups. Aviv REIT completed more than $150 million worth of acquisitions in 2012, including many assisted-living facilities and skilling nursing homes all over the U.S. Then the Chicago-based REIT filed to go public at the end of December, and it plans to raise up to $300 million from the public markets. Morgan Stanley, Bank of America Merrill Lynch (NYSE: BAC) and Goldman Sachs are underwriting the offering.
The Phillip Edison-ARC shopping spree continued into 2013. In February, the firm bought Fairlawn Town Centre, a 348,255-square-foot shopping center in Fairlawn, Ohio. A month before, the firm acquired Atlanta shopping centers with a combined 507,668 square feet for $61 million. These acquisitions pushed Phillip Edison's total portfolio to 33 properties with an aggregate purchase price of approximately $410 million. Other REITs, including Liberty Property Trust and One Liberty Properties, completed small deals as well.
"The most active part of the market-and the best opportunities-are not the billion-dollar transactions; they are actually the sub- $100 million deals because the assets that are becoming available today are from smaller regional banks and securitized lenders. Deals generated by financial institutions that need to sell will generate better returns," says Westport's Bernard.
While most deals completed by REITs have been on the smaller side, there have also been a handful of larger deals. For example, at the end of January, Macerich, a U.S.-based REIT, agreed to buy the Green Acres Mall, a 1.8-million-square-foot, super-regional mall in Valley Stream, N.Y., for $500 million. Additionally, in December 2012, Vornado Realty Trust bought the retail condominium at 666 Fifth Ave., New York, for $707 million. Lastly, and perhaps the most well-known deal, in January Health Care REIT Inc. (NYSE: HCN) took Sunrise Senior Living Inc. private in an $845 million all-cash deal, making it one of the largest owners of nursing homes in the U.S., Canada and Britain.
"The REITs and private equity firms have been more careful with what they are buying. There were some bad deals in the 2005-to-2007 timeframe," says Lowery. "The REITs and private equity firms that survived the downturn are going to continue to actively invest. I think this activity will continue throughout the rest of the year and into 2014, which is good news for sellers."
Strategic buyers have been making waves as well. "Real estate is a not a quarter-to-quarter business. It's long-term and strategic (buyers) are generally doing deals with a long-term plan, which makes them strong buyers," says Galligan.
One of the larger strategic deals happened at the end of 2012, when apartment building owner Archstone Inc. was sold to Equity Residential (NYSE: EQR) and AvalonBay Communities (NYSE: AVB) for $6.5 billion in cash and stock. About 60 percent of the company, or some 23,000 apartments, will go to Equity Residential, the country's largest publicly traded apartment company. AvalonBay, the second-largest public multifamily landlord in the U.S., is set to get the remaining 22,000 units, according to terms of the deal.
"The multifamily area is really active today as a result of changing demographics," says Lowery. "The fact is the housing industry has slowed down as a result of the economy. It is more difficult to get a mortgage loan. A slew of people who would have bought houses can't now. The apartment community has stepped into the breach. Another reason multifamily is doing well is cultural. Baby boomers wanted to buy their own homes and put down roots. The new generation is more mobile in their jobs and has seen people lose money with real estate. They don't want to be tied down. Also, baby boomers are beginning to retire and are looking to move back into urban areas, which is driving development in urban in-fill locations. All this has fueled activity in the multifamily sector."
Commercial real estate has piqued the interest of strategic buyers as well, and REITs have been acting as strategic buyers and buying other REITs. In January, Spirit Realty Capital Inc. and Cole Credit Property Trust II agreed to merge to create a commercial real estate firm with a combined enterprise value of $7.1 billion. The combined company, which will own or have an interest in 2,012 properties in 48 states, will be the second-largest publicly traded triple-net-lease real estate investment trust in the U.S. when the deal is completed. (In a triple net lease, the tenant pays the property taxes, building insurance and maintenance, in addition to the rent.)
Additionally, in January, Realty Income Corp. bought American Realty Capital Trust in a deal valued at $2.9 billion.
Of course, as is the case almost always with real estate, location can mean all the difference. "It's like a tale of two cities. Certain markets are strong and active, and in others there is no activity because it's hard to raise debt and equity capital to do the deals. The best returns should be generated in markets that lack liquidity," says Bernard.
Perhaps not surprisingly, buyers generally pay the highest prices in gateway cities, including New York, Boston, Washington, Los Angeles, San Francisco and Seattle. "In New York and other gateway cities the market is still strong for them. Move away to places like St. Louis, Cleveland and Denver, and the market isn't quite the same and there tends to be less trading. However, high-growth markets including Texas and Florida are seeing increased investment activity," says Lowery.
While overall acquisition activity has been great, some dealmakers worry that the market could end up back where it was in 2008 if investors don't act carefully. "The industry will need to maintain discipline to retain the strong underwriting of the last few years," warns Galligan.
Still, for better or worse, activity is expected to continue throughout 2013 and into 2014. "Very few people can predict when the market will turn. Some investors are chasing yield and therefore probably overpaying for the risk involved in owning a loan secured by real estate or the asset itself. If they are using leverage because they can get an asset a low interest rate, they have to hope that real estate prices will return faster than interest rates rise," says Bernard. "I don't believe the market is currently healthy; however, we will continue to see M&A activity. But it's important to remember it's a long-term investment. If you live long enough, even swamp land in Florida will be worth more. Great fortunes have been made by second- or third-generation owners. It's just a matter of how long you can wait."