REITs Prefer Asset Sales to Stock Issues

NEW YORK CITY—The public REIT sector has traded at an average 11% discount to NAV lately, Fitch Ratings reports, thereby reviving the popular slogan that real estate is "cheaper on Wall Street than Main Street."?Those discounted valuations in the public markets have REITs looking at asset sales, rather than stock issues, to fund investments.

Accordingly, the ratings agency expects real estate trusts to continue mining their portfolios for dispositions through the balance of 2015 and into next year to upgrade their portfolios, fund investments and possibly improve credit profiles. Certainly, a representative sampling of third-quarter earnings reports shows that dispositions have been on the agenda lately.

A statement from Lexington Realty Trust in connection with its Q3 earnings provides an example. "We are presently responding to offers totaling approximately $475 million and are reviewing broker estimates of value for another $425 million of properties that could be sale candidates," according to LXP's Nov. 5 statement. "We are 100% committed to taking advantage of market demand and pricing to market assets for sale, which allows us to restructure our portfolio, further reduce our exposure to the suburban office sector and accelerate our transition to a company with far more revenue from long-term leases and a more concentrated office footprint that we can manage more efficiently."

As the current year winds down, US equity REITs are on pace to exceed 2014's record $37 billion of asset sales. Companies sold roughly $40 billion of properties during the trailing 12 months ending Sept. 30, and Fitch says it expects fourth-quarter sales volume to be stronger this year.

Fitch's report points out that REIT privatizations, of which there have been several in the current year—totaling more than $20 billion of completed or pending take-outs—don't count as part of its asset sales total. "Whole-company sales are not an alternative equity source to share issuance, but they are emblematic of the discounted valuations for REITs generally as well as the strong demand for commercial real estate from institutional investors, including private equity," according to Fitch. Citing data from Preqin, Fitch notes that private real estate funds have 30% more dry powder than they did at the end of last year.

With $11 billion in dispositions, office REITs led the way over the 12 months that ended Sept. 30. Regional mall REITs accounted for about $5 billion of the total, as did shopping center REITs. The latter tally doesn't include Kimco Realty Corp.'s October disposition of its 50% share of a joint venture with Riocan Investment Trust, from which Kimco realized $755 million. Similarly, the multifamily sector's share of dispositions is expected to grow in 2016 due to Starwood Capital Group's planned acquisition of $5.3 billion of apartments from Equity Residential.

There is a downside to dispositions, though. "Asset sales provide funding at valuations in the private real estate market that generally exceed REIT's public market share valuations today,' according to Fitch's report. "However, in contrast to issuing equity, the lost income from dispositions can cause leverage for REITs to tick up modestly, assuming any property-level debt is at or below the corporate average. Fewer assets also generally mean less diversification and there is risk of adverse selection in portfolio quality."???