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Is the Public/Private Valuation Gap Closing?

(There may be a change in the air. After months of watching the Great REIT Disappearing Act, the differential between valuations on the public and private side may at last be closing. Some 60% of the respondents to last week’s Feedback Poll think so, and commentator White predicts that the playing field will continue to even out as we get through ’07. His thoughts appear below.-ed.)

There’s definitely an arbitrage opportunity, but it’s a temporary phenomenon. It’s been with us for well over a year now and it seems to have a little energy left, but I do expect that the difference between public and private valuations will be self-correcting over the next year.

Part of what’s fueled the trend is the availability of debt in the private sector that the public markets are hampered in accessing. And while debt will continue to be plentiful and very liquid, as we’ve seen over the past month, everyone is looking again at their risk premiums, and all the markets are looking at the underwriting. So I think we’ll see the banks become a little more conservative than they have been.

But the public REITs in the market now have an equity capitalization of about $350 billion. The real estate mutual fund industry is now about $60 billion or $65 billion. Every time an Equity Office disappears, all that capital has to go and invest in a dwindling number of remaining REITs. That’s a lot of capital that has to stay invested in REITs, and as the supply dwindles the price of the others goes up.

We’ve still seen companies go public. In fact, in the fourth quarter, we saw the largest REIT IPO ever by Douglas Emmett. So while they’re trading at a discount to their net asset value, which makes it tough to raise and deploy capital, they’re not totally off the market, and some REITs are trading much better than others. So the current trend is not as macro as it seems.

We’re going to continue to see cycles when the public markets will value real estate more; now the reverse happens to be true. There is some expectation that some of the larger privatizations may end up going public again.

Bob White is founder and president of Real Capital Analytics in New York City. This year he was voted by the editors of Real Estate Forumas a “CEO To Watch.” The views expressed in this article are the author’s own.

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