REITs GO ON A SPENDING SPREE

REITs are on the rise again. They've raised billions of capital in the past few years, and many are seeing strong returns.

In fact, NAREIT reports that the total return of the US REIT market outpaced the broader equity market in the past year. With returns of 11.29%, REITs beat out the S&P 500's 8.54%. All the while, REITs are still raising significant dollars. They raised $21.1 billion in the first quarter of 2012, including $10.6 billion of equity, NAREIT reports. That compares to $51.3 billion in all of 2011.

The question now is, how are REITs spending all this cash? The answer is varied. Although some are refinancing debt or doing mergers, most are acquiring or developing properties—or both. With distressed assets still up for grabs and new development opportunities arising in certain sectors, REITs are putting their cash to use in 2012.

On the acquisition scene, the billions of dollars REITs have raised—combined with the newly available commercial real estate inventory that's coming to market—is creating a perfect storm of sorts. Public companies have been staking up dollars through the downturn, but quality commercial properties were hard to find. Commercial assets were often either tied up in bank-owned purgatory or with stable sellers who were unwilling to sell at a discount in a down market.

In 2012, all that is changing—and fast. NAREIT estimates about $20 billion in five-year commercial real estate loans made at the peak of the last real estate cycle are coming due, and many will have difficulty finding refis. "We're seeing a big increase in equity and debt offerings because there are now properties for REITs to acquire," says Brad Case, senior vice president of research at Washington, DC-based NAREIT. "REITs have a competitive advantage when it comes to accessing capital and will move to acquire properties from non-REIT investors who got into trouble."

With new inventory coming to market, some REITs are changing up their strategies. Weingarten Realty Investors has historically held a fairly diversified portfolio, but as the market shifts the REIT has divested its industrial portfolio to focus on retail. The Houston-based firm sold its industrial assets, which included 52 properties spanning about 9.6 million square feet, to DRA Advisors for $382.4 million in April.

"The sale of this portfolio demonstrates our commitment to the company's capital recycling initiative," says Drew Alexander, president and CEO of Weingarten. "It is a significant step toward the strategic exit from industrial real estate, further strengthening our position as a pure-play retail REIT."

Jahn Brodwin, New York City-based senior managing director of corporate finance and restructuring at FTI Consulting, sees this as a clear trend and one that will gain momentum in 2012. He calls it "getting back to basics by reshuffling the deck.

"On the one hand, you're seeing REITs raise a lot of capital," Brodwin says. "On the other, you're seeing them redeploy their balance sheets, refocus it or focus it for the first time. We've seen a lot of REITs selling off assets and redefining their core business rather than raising new capital."

Multifamily isn't a new story in the commercial real estate market recovery, but it's still the hottest sector in town. REITs like Colonial Properties Trust and AvalonBay Communities are posting AvalonBay Communities are posting strong earnings against their multifamily strategies. And it's not just about acquisitions of distressed or class A-plus assets in prime markets. Developers, including REITs, are starting to put shovels in the dirt again.

"At this point in the cycle, we remain focused on unlocking the value of our land by developing and simplifying the business through selective commercial dispositions," says Thomas Lowder, CEO of Colonial Properties Trust. The Birmingham, AL-based REIT is currently developing five multifamily complexes spanning 1,475 units with a $193-million development budget.

For its part, AvalonBay launched two new apartment brands in December: AVA and eaves. The Arlington, VA-based trust's goal is to drive more diversity in its multifamily offerings as its next wave of development begins. The new AVA brand, for example, is designed to attract Gen Y and others who want to live in or near urban neighborhoods (for more on this, see Multifamily Quarterly: Urban Invasion, page 52). The eaves brand aims at a segment of renters that want good quality apartment living with practical and functional amenities and services.

"Our development program starts at about $1 billion a year," says John Christie, senior director of investor relations at AvalonBay. "By year's end, we should have about $2 billion. Given the volatility of the capital markets, it makes sense to load up with as much as you need as soon as you can. At $1 billion a year in multifamily development, that's about 12% of our total market cap. That's comfortable for us."

Following the rise of multifamily, student housing REITs are also spending cash on new developments. American Campus Communities has been one of the most active, recently breaking ground on several new projects, including a 454-bed student community at New York's College of Staten Island. ACC also teamed up with Texas Drexel University to build a $97.6-million 361,200-square-foot mixeduse housing and retail space.

But ACC isn't relying on development alone to drive returns for its shareholders; it's also making strategic acquisitions. Recent examples include 26 West Apartments in Austin and a controlling interest in the Varsity in College Park. The total spend: $208 million.

"These two acquisitions, along with our 11 owned developments being delivered in fall 2012, represent $593 million in premier core assets," says Bill Bayless, CEO. "Each of these 13 properties meets our investment criteria of a differentiated product located either on campus or within walking distance to each respective university, and are located in submarkets with barriers to entry."

On the other end of the spectrum, senior housing REITs are almost as active. Senior Housing Properties Trust is among the niche REITs that are spending cash on acquisitions. Since January, the trust has bought, or inked agreements to acquire, 14 properties for $340.5 million. And CNL Healthcare Trust spent $84 million in five properties in February and followed that by acquiring another four assets for $79.8 million in May.

"We're focused on forming solid relationships with companies who wish to sell senior living properties but continue to operate them, and I think that's appealing to many potential sellers," says Steve Mauldin, president and COO of CNL Healthcare Trust. "However, we are aware that there may be some good opportunities to purchase assets and insert new operators when a seller wishes to exit the market, and we're open to those investments as well."

Although multifamily is the hot ticket in town, some REITs are also pursuing office towers. The office sector has been among the hardest hit in recent years. Distressed opportunities remain, even as demand for trophy towers in gateway cities rises. Still, a full recovery seems years away.

Without a doubt, the REIT office industry continues to suffer at the hands of a weak job market. Compared to prerecession levels, the economy is still down about four million jobs and vacancy rates remained flat at about 16% in the first quarter. Tenants are increasingly focused on space optimization.

Some REITs are dumping office towers—Liberty Property Trust recently sold 49 office and flex properties for $195 million and Corporate Office Properties Trust disposed of seven stabilized properties, two vacant properties and a parcel for $651 million—while others are on a buying spree.

Vornado has been the most active REIT in the office sector this year. In January, it inked a $300-million refi on 350 Park Ave., a 558,000-square-foot Manhattan office building. Vornado also refinanced Eleven Penn Plaza for $330 million, realizing $126 million in proceeds, and sold 350 West Mart Center, a 1.2-million-squarefoot Chicago office building, for $228 million, with a net gain of about $54 million. The REIT then turned around and bought 1399 New York Ave., a class A trophy office building in the Washington, DC CBD close to the White House, for $104 million.

Boston Properties is also making its mark. In March, the REIT acquired 100 Federal St. in Boston from an affiliate of Bank of America for about $615 million. The REIT funded the deal with available cash. Meanwhile, Brookfield Office Properties, together with its Canadian Office Fund partners, sold the Altius Centre office building in Downtown Calgary for $179.8 million. Canadian Real Estate Investment Trust and KingSett Capital each purchased a 50% interest in the tower.

Healthcare is a vibrant sector of the commercial real estate world. And Health Care REIT is one of the best examples of that. In the first quarter, Health Care REIT announced $508 million in acquisitions, $269 million in assumed and newly arranged debt, a $1.1 billion common stock offering and other market moves.

Indeed, the Toledo, OH-based company is turning heads in the market with a major expansion into Canada. In a deal worth $925.2 million, the group partnered with Chartwell Seniors Housing REIT to own and operate a portfolio of 42 seniors housing and care communities with approximately 8,200 units located in a variety of attractive Canadian markets.

The investment, says CEO George Chapman, "takes our successful US investment strategy and applies it to the Canadian market. HCN will gain a meaningful foothold in Canada's largest and most attractive markets with a portfolio of high-quality private pay facilities, and benefit from a relationship with Canada's leading seniors housing operator."

Meanwhile, the hotel industry is picking up momentum. Marcus & Millichap reports commercial and regional banks have eased into lending on strong hotel assets for qualified borrowers with solid balance sheets. REITs are also getting into the game.

In January, a Vornado Realty Trust fund recapitalized the Crowne Plaza Hotel in Times Square, a 795-key hotel with 15,000 square feet of prime retail space. The new venture plans to reconfigure and reposition the retail and office space as well as add additional signage. And Pebblebrook Hotel Trust acquired Hotel Milano in San Francisco in April.

Some analysts are watching Pebblebrook closely. "Pebblebrook is well-positioned to capitalize on any deal opportunities that come its way in the second half," David Loeb, a senior analyst at Robert W. Baird & Co., wrote in a new report. "Our curiosity was piqued with Starwood's admission on its call that it was negotiating the sale of several of its owned assets. We believe only the W Westwood, W Chicago Lakeshore or W Times Square could be on Pebblebrook's radar."

Retail is on the rebound in gateway cities—and grocery-anchored shopping centers and triple-net leased assets are finding momentum even in second-and third-tier markets. Major retail REITs like Kimco Realty and Simon are leveraging their funds and assets to make the most of a recovering market.

Earlier this year, Kimco sold 15 of its shopping centers for $215.4 million. Specifically, the company sold 13 nonstrategic properties totaling nearly 1.2 million square feet for $95.9 million. Most of these properties were in locations outside of Kimco's target metros. It also sold a joint-venture property in Schaumburg, IL for $118 million.

The REIT then turned its attention to acquisitions. It purchased a 50% ownership interest in Orleans Gardens Shopping Centre, a grocery-anchored asset in Ottawa, Ontario, for $16.5 million. Also dipping its toes into redevelopment as the economy continues its slow recovery, Kimco partnered with General Growth Properties in a 50/50 joint venture ownership of Owings Mills Mall in Owings Mills, MD.

The companies will co-lead the redevelopment of the 25-year-old, millionsquare-foot regional mall. "Owings Mills Mall presents a wonderful value-creation opportunity in one of our core markets," says Mike Pappagallo, COO for Kimco Realty.

At the end of the day—or the quarter, in this case—REITs are also giving back to their investors. Lawrence Longua, director of the REIT Center at New York University's Schack Institute of Real Estate, says at least one-third of the REITs increased their dividends last year—and there's room to increase those dividends even more.

"If you take a look over any long period of time, dividends account for about twothirds of the total return of REITs," Longua says. "If REITs continue to pay dividends, it'll push up their stock prices. This is the most efficient way to use the cash they might be sitting on. The REITs have finally brought their balance sheets back to where they were in 2007."

Most US REITs have historically stayed stateside. But there seems to be a growing interest in overseas investments by trusts, which could signal a renewed opportunity for these groups to expand their global retail real estate footprint.

Steven Marks, head of US REITs for Fitch Ratings, points to Simon Property Group. "Simon recently started growing more internationally as opposed to looking for acquisition or growth opportunities domestically," Marks says. "It's had international exposure in the past, but the volume of new acquisitions and projects could signal more opportunities for REITs overseas."

In mid-April, Simon announced a joint venture with BR Malls Participacoes S.A., the largest retail real estate company in Latin America. That announcement came on the heals of new construction projects breaking ground in Japan and Canada through separate joint ventures and Simon's purchase of a 28.7% stake in Klepierre, a publicly traded owner of European shopping centers, for about $2 billion.