Ever since the introduction of modern REIT-enabling legislationin the US in 1960, public ownership of commercial real estate hasgone through a series of growth spurts, often followed by slightcontractions as real estate owners followed the ebb and flow of thecapital markets.

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The last major growth spurt for REITs was in the 1990s whenaccess to private capital was limited and the public equity marketsprovided a greater opportunity for real estate owners to accesscapital to expand their businesses. Today, similar conditions existin the real estate capital markets and it appears we may be on thecusp of another era of great REIT formation.

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In March of 2009 Simon Property Group succeeded in selling 17million of its shares at $31.50 a share despite a severe creditcrunch and a deep recession. Simon’s offering helped to buildconfidence that the REIT sector could raise capital and thus pavedthe way for more REIT IPOs. In total, there were nine other REITIPOs totaling about $3 billion in 2009. This year, six IPOstotaling about $1.16 billion had been completed as of mid July,including Hudson Pacific Properties’ successful $218 million IPO.Some offerings have been structured as blind pools, with sponsorsplanning to invest the proceeds in distressed real estate or otherassets. Others have been structured as rollups, with a sponsorrolling up assets into an operating partnership owned by a REIT andtaking the REIT public in an IPO.

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The pace of REIT IPOs is quickening. In late June, HudsonPacific, a company that invests in office and media andentertainment properties, mainly in California, raised $218 millionin a REIT IPO. Concurrently with the completion of the IPO, HudsonPacific completed a private placement of $20 million of commonstock to its chairman and CEO, and certain affiliated investmentfunds, at the initial public offering price.

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To be sure, not all REIT IPOs have been successful. Some werewithdrawn due to the choppy stock market or because sponsors couldnot get the initial offering price they wanted. Other offeringsraised less equity than sponsors hoped for. But this has notdiscouraged sponsors from moving ahead. More REIT IPOs are in thepipeline, including those sponsored by hospitality, health care andoffice/industrial companies.

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Going public can be attractive to private real estate companiesfor a number of reasons. The public capital markets provide analternative source of capital, enabling companies to pay down debt,recapitalize their balance sheets and build liquidity. Properlystructured, assets can be contributed to a REIT-owned operatingpartnership in a tax-free transaction.

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Another reason for going public is that, according to GreenStreet Advisors, Wall Street currently values real estate at 15% to20% more than Main Street. Thus a portfolio of properties owned bya private company might have a value of $500 million, but as aREIT, the value of its properties might be $575 to $600 million.REIT-owned properties command a premium because REITs provide aliquid form of investment, transparency, competitive dividends,professional management and other benefits; and investorsapparently expect property markets to recover as the economygradually improves, with vacancy rates declining and rents startingto increase.

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While REITs have accumulated substantial equity throughsecondary offerings and IPOs, they have been slow to invest thatequity in properties even though asset values have fallen as muchas 40% from their 2007 peaks. Property acquisitions by public REITsdropped from 6,351 in 2005 to 360 in 2009 and transaction activityhas remained subdued this year, for a variety of reasons. Bankshave been reluctant to take the writedowns from foreclosing onloans in default and selling the properties collateralizing thoseloans. Instead, they have worked with owners to extend loans orfind other alternatives to foreclosure. This has reduced theincentive for owners to sell properties immediately to pay loansoff. Some owners are clearly waiting for property values toincrease before putting their properties on the market.

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But pressure could be building for banks and owners to startselling properties. About $1.24 trillion of US commercial realestate loans ($1.02 trillion held by banks and $221.5 billionbundled into CMBS) will need to be refinanced over the next fouryears. Otherwise the properties will have to be sold by banks inforeclosure proceedings or by owners themselves, and this couldcreate more buying opportunities for REITs.

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It’s uncertain when the public capital markets will be receptiveto more REIT IPOs in the current cycle, but private real estatecompanies are trying to take advantage of the opportunity whilethey can. To succeed, they will need to have a powerful story tosell Wall Street: their track record, differentiation fromcompetitors, how they plan to invest equity proceeds, why theirmanagement team is well qualified to manage a public REIT, whytheir balance sheet is healthy, how they plan to manage the risksof investing, and other issues of deep concern to investors. Aswe’ve seen recently, not every private company can make it throughthe IPO window, but for those that succeed, long-term opportunitiesshould be available to deploy this capital to grow theirbusinesses.

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Howard Roth is the GlobalReal Estate Leader and a partner with Ernst & Young LLP’s RealEstate practice. He may be reached at [email protected]. Theviews expressed herein are those of the author and do notnecessarily reflect the views of Ernst & Young LLP.

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Howard Roth

As the Global Real Estate Leader, Howard coordinates the firm's activities across a broad array of related services around the world. EY has the largest integrated real estate practice of any Big Four firm, with more than 7,500 professionals around the world providing audit, tax, transaction and advisory services to owners, builders, lenders and users of real estate. EY serves more than 4,000 real estate clients throughout the world. Howard brings more than three decades of experience in the real estate industry. He has worked extensively with major real estate private equity funds, domestic and offshore real estate investment trusts and large public homebuilders, as well as numerous construction and hospitality companies. His credentials include a BA in Accounting from Hofstra University. He is a member of the American Institute of Certified Public Accountants and New York, New Jersey and Connecticut Society of CPAs, has been a columnist for several major industry publications and is frequently a speaker at key real estate industry events.