REITs Will Ease Up on Investment Pace: EY

NEW YORK CITY-Although REITs expanded their share of global transaction activity from 14% to 20% year over year during the first six months of 2013, they're not likely to maintain that pace going into 2014. So says EY in its sixth annual global REIT report, published on Monday.

“REITs have been very active in the acquisition market in the last three years, adding US$230 billion in assets during that time, so it is hardly surprising that they take a little time to digest that activity,” says Howard Roth, EY's global real estate leader. Although Roth notes that the six-month tally of US$60 billion in the year's first half is “still very strong,” but he adds, “many REIT teams see challenges ahead in identifying suitable targets, both in terms of the quality of asset and pricing.”

EY compiled this year's survey, “Global Perspectives: 2013 REIT Report,” from interviews with major real estate clients around the world. Additionally, the firm conducted a survey among more than 80 global REIT CFOs in August.

One lesson to be taken from the CFO interviews is that REITs aren't focused on increasing their scale through merger activity. Those trusts that have done so recently are still working through the integration process. “REITs have a 'never say never' approach to the possibility of transformative acquisitions, but nothing in our survey suggests that we will see a trend toward large-scale mergers in the next 12 to 24 months,” says Robert Lehman, EY's global REIT leader.

A higher priority, according to EY, is making REIT organizations more nimble and efficient from an operational standpoint, reducing costs and managing risk. This is especially true in the US, where the REIT market is largest and more mature. For example, operational, general and administrative costs for US REITs declined by half a percentage point between 2006 and 2012 and now stand at 4.5% of un-depreciated book value of property.

“The overwhelming trend among all REITs is to transition from an entrepreneurial style of managing their business to a mature, more efficient approach,” Lehman says. “Efficiency and effectiveness are becoming real differentiators across the sector.”

That's particularly evident in how REITs approach debt financing. Increased leverage among US real estate trusts was largely responsible for a two-year increase in total REIT debt from $361 billion in '10 to $372 billion at the end of last year. Yet REITs have successfully mitigated the risk of taking on additional debt by “laddering” debt maturities over the past few years. This provides a degree of protection against future interest rate increases and has made REIT debt maturity profiles a “manageable concern,” according to the report.

Another area where REITs are becoming more efficient is in development and construction. EY estimates that development and construction costs for the 15 largest US REITs increased from $2 billion in 2010 to $3 billion last year and that more REITs will move into development, whether to deliver new projects or build upon their existing assets. Especially among larger REITs, EY sees “rigorous monitoring” of development and construction expenditures.