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With rare exceptions, the REIT sector over the past few years has outperformed the broader stock market. In the first quarter of this year, for example, the FTSE NAREIT All REITs Index, which includes both equity and mortgage trusts, produced a 4.05% total return, while the equity REITs index delivered a 3.98% total return and the mortgage REITs index 2.35%. All three metrics dwarfed the S&P 500's 0.95% return for the quarter, and REITs' dividend yields also surpassed those of the S&P 500. However, even amid what would seem to be a climate of market receptiveness, industry experts tell Real Estate Forum that getting an initial public offering off the ground means clearing a very high bar, a fact that may limit the number of IPOs we see this year.

In fact, conditions supporting a REIT IPO are generally favorable, “for the right companies,” Dirk Aulabaugh, managing director in the advisory & consulting group with Green Street Advisors in Newport Beach, CA, tells Forum. A recent podcast with Esposito Securities' David Auerbach pointed to the success of IPOs by Paramount Group and STORE Capital in the fall of 2014 as a harbinger of more to come this year, despite the fact that 2014 was an especially quiet year for such transactions. Given the market's favorable reception for both offerings, with the PGRE IPO in particular setting a new record at $2.6 billion, “I think you're seeing a lot of the non-traded guys potentially lining up to do the same thing,” Auerbach, institutional trader with Dallas-based Esposito, told REIT.com.

Bearing out Auerbach's prediction, Easterly Government Properties and a trio of mortgage REITs—Sutherland Asset Management, Reverse Mortgage Investment Trust Inc. and Great Ajax Corp.—filed for IPOs as 2014 became 2015. American Realty Capital Trust V in April filed to go public, with plans to begin trading on the New York Exchange during the third quarter. It was the second American Realty Capital-sponsored non-traded REIT in as many months to announce that it was headed toward the NYSE, following American Realty Capital Global Trust in early March.

When ARCT V is listed, it will be under the name American Finance Trust Inc. and the stock ticker AFIN, reflecting an expanded purview into originating and acquiring first mortgages and other CRE debt securities. The company sees commercial mortgages as an investment opportunity that has been underutilized by REITs. It plans to tap into the opportunities to complement the stable cash flows it receives from its net lease portfolio.

Aulabaugh also points to recent and forthcoming IPOs from non-traditional sectors, as well; “it may broaden the menu of options for investors,” he says. He cites the recent stock-market debut of InfraREIT, a real estate trust that owns electric transmission and distribution assets across the Southwest. Initially priced at $23 per share, the stock closed at $26.60 per share before the IPO was completed in late January. The IPO brought in more than $460 million before expenses and gave the company a market capitalization of $1.2 billion.

Not incidentally, InfraREIT came to market with some powerhouse backing: Hunt Consolidated, the real estate and energy conglomerate owned by Ray L. Hunt. Also in the non-traditional space, the Blackstone Group is planning to take its single-family rental business public within the next year or two. REIT.com reported that Jonathan Gray, global head of real estate, in late April told an audience at the Real Estate Luminaries Series at Georgetown University's Steers Center for Global Real Estate that his company is in the process of “building something that will look like an apartment REIT.”

Such a REIT would come to the market with the imprimatur of, well, Blackstone, which has had a string of successful real estate IPOs in the past two years, although not all in the REIT space. Along with Brixmor Property Group, a shopping center REIT that grew out of Blackstone's $9-billion acquisition of Centro Properties Group's US holdings in 2011, Blackstone also took Hilton Worldwide Holdings and La Quinta Holdings public after taking them private a few years earlier. The forthcoming SFR IPO from Blackstone and the recent infrastructure IPO from Hunt Consolidated are in keeping with the kind of credentials that Aulabaugh sees as necessary for a successful REIT IPO.  

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To illustrate the pedigree that he sees as essential in a REIT IPO, Aulabaugh cites the examples of PGRE and STOR. In the case of PGRE, he points to “a very focused strategy on certain gateway markets” and a management team, led by CEO Albert Behler, that has “a really strong track record.” Given that PGRE's publicly-traded debut in November 2014 was oversubscribed and eclipsed the $1.6-billion REIT IPO record set by Douglas Emmett Inc. in 2006, “Investors just gravitated toward the quality of the assets and the management team and, in particular, the fact that the assets were in these gateway markets,” says Aulabaugh.

Regarding STOR, which raised $585 million in another oversubscribed IPO this past November, Aulabaugh notes that “a lot of people are getting really excited” about the net lease sector. Green Street sees the sector in general as “trading at a pretty meaningful premium right now. I think that's a green light for a company like STORE Capital to go public.” The acronym in the company's name signifies single tenant operational real estate, its market niche.

Aulabaugh also points to STOR's management team, especially CEO Chris Volk, who has taken three companies public since 1994, including Spirit Finance and Franchise Finance Corp. of America as well as STOR. “He has already round-tripped two companies prior to this, and made shareholders quite a bit of money,” Aulabaugh says of Volk. “I think all investors were excited to see him bring another company public, because they have so much confidence in his ability, and his management team's ability, to create value for shareholders.”

In a visit to Forum's offices earlier this year, Volk provided insights into the thinking behind the decision to take STOR public. Given that REITs grow by continuing to buy new assets and to raise new equity capital, he told Forum, “When you list a company on the New York Stock Exchange, you're basically making a strategic decision that this is where you want to be for the foreseeable future as far as raising equity capital is concerned.”

A non-traded REIT, Volk said, has choices to make. “Do you raise capital privately, which we've done already for three and a half years, or do you raise it publicly? Our choice to go to the public markets was because we think it'll help lower our cost of capital and make us more efficient, not just today but in the future.”

That choice means that STOR eventually will move away from being a controlled company; post-IPO, Oaktree Capital Management maintains a 70% controlling stake in STOR. “As we raise capital over the next several years, that will gradually diminish and be replaced with broader institutional and retail investors,” said Volk.

Even Volk's formidable track record of taking companies public likely wouldn't have won over would-be stockholders if the other elements for success weren't also in place, Aulabaugh says. “If you have a company that's trading at a meaningful discount to NAV, a good management team might not make that a successful IPO, because they're not going to want to take your company public in an environment where issuing equity would be dilutive to your shareholders,” he says. “We do see companies issue equity at a discount, but there's an inflection point where they say 'okay, this makes sense' or 'this does not make sense.' Management is very important to the process, but the sector in which they're operating, the properties they operate and the quality of those properties are also very important. It's a basket of all those characteristics together.”

That being said, Aulabaugh says these factors generally go hand in hand. “Top-notch management teams tend to own assets that the investment community is going to covet,” he says.

Another factor for investors to consider, says Aulabaugh, is corporate governance. “How shareholder-friendly are they? What's their disclosure look like? Are investors able to figure out what the company's really worth, based on the disclosure in the company's S-11? It's all these factors that people look at to get to what they would consider a fair price.”

The need to satisfy a number of investor requirements informs Brad Case's assessment of the IPO volume we can expect this year. “The question I often get is whether we're going to see an IPO boom in the REIT industry, the way we saw in the early 1990s,” says Case, SVP of research and industry information at NAREIT. He tells Forum that while there will be continue to be some IPOs, the kind of boom that Kimco Realty Corp. ushered in with its 1991 stock-market debut isn't in the cards.

“The simple reason is this: back in the 1990s, there weren't that many publicly traded REITs, and they weren't recognized generally as terrific operating companies,” says Case. 'Now they are. The result is that if you want to do an IPO now, you have to have a combination of a strong portfolio of properties, a strong balance sheet and a strong management team. If you don't have all three of those, you're going to have a lot of trouble competing for capital with the existing publicly traded REITs.”

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Case acknowledges that not all publicly listed REITs can claim to have these attributes in abundance. “But there are enough companies that do that it's very hard to compete,” he says. He points to Simon Property Group, Ventas Inc., Boston Properties and Public Storage as “strong companies that do more or less everything investors want. You either have to show that you have a superior portfolio or management team, which is pretty hard to do, you have to show that there isn't an A-team REIT in your part of the market already or you have to come into an entirely different part of the market.”

Aulabaugh says “it's a tough question to answer” on whether the favorable conditions for REIT IPOs will actually lead to more of these transactions. “You have two buckets, really, he explains. “You have companies in the traditional property sectors—office, industrial, retail. Those companies have a number of options; going public is one of them.”

However, he points out that one such company was Blackstone's IndCor industrial platform, which Blackstone considered taking public before selling it for $8.1 billion to GIC Pte. Ltd., Singapore's sovereign wealth fund, and Singapore-based industrial landlord Global Logistics Properties Ltd. “There's a tremendous amount of capital out there looking for these opportunities,” Aulabaugh says.

In what Aulabaugh calls the “non-traditional” sector, he sees “a tremendous amount of creative thinking around how these PropCo/OpCo and REIT conversion companies are thinking about things.” He predicts that we'll likely see more of these transactions—which often result in newly listed REITs without an IPO occurring—this year than we did in 2014.

The next year or two may, or may not, see a wave of retail companies spin off some or all of their corporate-owned properties into REITs. Sears Holdings Corp. announced last month that it had filed to establish Seritage Growth Properties as a standalone REIT with a portfolio of 254 stores covering a broad geographic swath and spanning 40.3 million square feet. It will include 158 Sears stores, 85 Kmart locations and 11 properties leased entirely to third parties.

If activist investors had their way, SHLD and Seritage would have plenty of company. Maracato Capital Management has urged department store operator Dillard's Inc. to spin off its real estate into a standalone REIT. A PropCo/OpCo division of the parent company and a department store REIT would value the two companies at a combined $193 per share, representing a 75% increase from current prices, according to a Marcato presentation this past November. “We encourage Dillard's board and management to actively explore this opportunity to the extent it is not presently doing so,” managing partner Richard McGuire said at the time.

Land and Buildings' founder and CIO, Jonathan Litt, made a similar case in March with a call for MGM Resorts International to explore options that would include a PropCo/OpCo spinoff. He cited factors ranging from the company being undervalued to an opportunity for MGM to repay half of its $5 billion in near-term debt with no penalty. Although MGM said it would consider the proposal, Litt subsequently told the casino-resort operator's board that he's not seeing much forward momonetum on implementing his plan.

Also in March, shares of McDonald's Corp. rose when Larry Robbins, CEO of Glenview Capital Management, became the latest in a line of investors who have advocated over the years for the fast-food giant to unlock the value of its real estate. However, MCD CFO Matthew Paull told analysts that moving ownership of some 13,600 locations over to a REIT would be cumbersome and cause “irreparable damage” to the company's franchisee relationships. In early May, MCD, which has been hit with faltering sales over the past several months, unveiled a comprehensive global turnaround strategy, but a REIT conversion was not on the menu.

Aulabaugh sees two factors underpinning the interest in PropCo/OpCo splits. “Number one, you get some tax savings by having the real estate in a real estate investment trust,” he says. “Secondly, you're able to unlock the value of the real estate at a time when real estate values are at an all-time high. And it provides some transparency to investors in terms of how much value is in that real estate.”

One disadvantage that Aulabaugh sees in the PropCo/OpCo format is tenant concentration. “Typically you have one tenant when they actually do the spin-off, so the investors are very focused on the credit of that tenant, as well as the quality of the properties. 'Are these good assets that we want to own?' Those are some of the things that stakeholders and shareholders should be thinking about.”

At the REITWise 2015 conference held in Phoenix in early April, Mark Van Deusen, partner with law firm Hunton & Williams LLP, said in a video interview that the growth of spinoffs has taken the edge off demand for new stock exchange-listed REITs. “The desire for new niche REITs is being met in large part by the spinoff market,” he told REIT.com. “That has depressed the vitality of the IPO market.”

In recent months, Vornado Realty Trust has carved out its suburban retail portfolio into a separate REIT that began trading as Urban Edge Properties in January. There was no IPO marking the spinoff; prior to UE being listed on the New York Stock Exchange, shares traded on a “when issued” basis on the NYSE under the UE WI ticker. More recently, Inland American Real Estate Trust spun off its lodging platform as Xenia Hotels & Resorts Inc. through a taxable pro-rata distribution. The spin-off gives XHR an opportunity to establish itself independently and focus on the lodging sector, Marcel Verbaas, the REIT's president and CEO, told REIT.com in a podcast.

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Simultaneously with its April announcement that it would bulk up its presence in one healthcare segment—hospitals—VTR said it would largely exit another by spinning off the bulk of its post-acute/skilled nursing facility portfolio. The healthcare giant expects to complete the spin-off in the second half of this year, and it's intended to qualify as a tax-free distribution to VTR shareholders.

To be known as Care Capital Properties Inc., the new company will launch with 353 SNF and acute care properties operated by 43 private regional and local care providers. It will pursue a strategy focused on investment opportunities with regional and local operators in the highly fragmented SNF market.

The Urban Edge, Xenia and Care Capital transactions are only the most recent examples of the trend. A newly published “2015 Spin-Off Guide” from law firm Wachtell, Lipton, Rosen & Katz cites others that occurred in 2014, including CBS's IPO of its CBS Outdoor Americas business, Simon Property Group's spin-off of its strip center business and smaller enclosed malls into a standalone REIT—which subsequently merged with Glimcher Realty Trust—and Penn National Gaming's spin-off of its real estate assets into the first-ever casino REIT.

Such transactions are not easily managed. “Separation transactions involving REITs can be complex, given the requirements for tax-free treatment of the transaction and the rules that an entity must comply with in order to be treated as a REIT,” according to Wachtell Lipton's spin-off report. “Among other things, in order for the separation to be tax-free, the separation must have a non-tax corporate business purpose and the REIT must conduct an 'active trade or business,' while, in order to qualify for favorable REIT treatment, the REIT must have no earnings and profits from the pre-REIT period.”

More generally, Wachtell Lipton cites other potential downsides of spin-off separations. Among them are: the potential loss of both revenue and cost synergies associated with having two separate public companies; disruptions to the business as a result of the spin-off; separation costs; reduced size and diversification, with the possibility of greater cash flow volatility and reduced access to capital markets; the potential reduction of equity research coverage and investor focus if the separated companies are too small; potential stock market index exclusion depending on the size or nature of the companies; and the possibility of increased vulnerability to unsolicited takeover activity.

Regarding the burgeoning trend toward spin-offs, Case says, “It's certainly good that people are thinking about different ways of adding value. The problem is that fro m the investors' point of view, each of the pieces has to make sense on its own as a business.”

In cases where the management of an existing publicly traded REIT sees that there are two distinct property types in the company's portfolio and therefore opts to spin off part of its operations, “in many cases the investors are going to cheer that on,” says Case. “They want more control over the type of exposure they have. More generally, investors are going to ask whether each of these pieces makes sense on its own. It's no good to simply carve up assets; you have to carve them up in a way that you have a good management team for each set of assets, and a good balance sheet for each set of assets.”

On the other hand, he says, “sometimes mergers don't make sense, and de-mergers do make sense. The stock prices will respond accordingly. Investors have their own way of judging, and if they disagree with management on something, that will be reflected in stock prices. But we have seen some examples of de-mergers of some sort where investors liked what was going on.”