Key Takeaways: Yesterday real estate industry publication The Real Deal ran an article To REIT or not to REIT, discussing recent activist /deal activity / commentary on potential take-outs of serially discounted office REITs. By way of background the office REITs, and in particular the Coastal Gateway office REITs, consistently traded at ~15-25% discounts to NAV over long durations pre-pandemic, after which the discounts blew out to 40%+ and higher. At issue were the following which would clearly inhibit assets from realizing private market value in a publicly-traded REIT structure: (1) “lumpy” and unpredictable earnings and cash flow period-to-period, (2) high G&A & Capex burdens relative to other REITable asset classes, (3) oftentimes small scale / inefficient corporate layers / lack of true platform value, (4) high embedded transaction costs in any deal, and (5) entrenched management teams unwilling to sell to name a few. Layer on top the fact that NAV is subjective, and oftentimes estimates did not differentiate between “going concern NAV” and a probability weighted estimate of private market value. Said another way, if the probability of take-out is low and it has been, then going concern NAV is more appropriate and by definition lower as G&A and Capex need to be included in the analysis. Put simply, the asset class is relatively uneconomic sitting within a public structure.
Following the rebuffed take-private offer for PGRE by activist Bow Street in late-2020, a similar play by Arkhouse for CXP which is ongoing (which we wrote about HERE), and the pending close of the BAM / BPY deal, it appears the logjam may be loosening somewhat. Significant hurdles remain, however, particularly on the transaction cost side which is often underestimated by the market. Also, the “social” aspects need to be discounted, i.e. the willingness of management teams to work with an acquiror / each other, and this has always been VERY low particularly in New York. At this point it still makes sense to look to the office subsector as a recovery play versus playing take-out odds, with a meaningful uptick in leasing still several quarters away and overall activity lagging behind the apartment subsector. Whatever the consensus "NAV" is, the stock should be trading at a significant discount to that number until further notice.
Tonight’s 1Q Earnings Reports:
- Industrial: EastGroup (EGP) will give us data on shallow-bay warehouse in the Sunbelt
- Apartments: AvalonBay (AVB), Equity Residential (EQR) and Essex (ESS) provide a look into Coastal Gateway apartments – expect West Coast (ESS) to be faring slightly worse for now
