REITs Too Hot to Touch

The REIT privatization wave has helped send the sector's share prices sharply higher, but that rally could cause the deal spigot to dry up.

A few months ago, the argument could be made that REITs' real estate portfolios were undervalued in the public markets based on where stocks were trading. That explained why private equity groups and other institutional investors were able to pay lofty premiums to take real estate investment trusts private and gain attractive real estate properties that could either be repositioned for the long term or flipped immediately for a nice profit.

There have been 15 REIT privatizations since the beginning of 2004, according to SNL Financial. After the Blackstone Group announced in early March that it would pay $5.6 billion for CarrAmerica (CRE), fellow office REIT stocks began running up in price as speculators made bets on who would be taken private next. The recent bidding war for Town and Country Trust (TCT) helped propel the apartment sector to lofty valuations. Year to date, the MSCI U.S. REIT Index is up about 13% on a total return basis -- much of it due to the privatization surge.

But the gap is now closing between the private market value of REIT assets and the public market value (as reflected in the stock price), says Matthew Lustig, who heads the real estate investment banking group at Lazard.

"In some cases, the public market may have caught up to private market value," Lustig says. There are a handful of REITs that had been expected to go private this year, he says, but with stock prices shooting up recently, it's getting harder for buyers to offer premiums.

"It's absolutely a much more challenging environment to consummate any transaction at a premium," says Joe Parsons, president of North America equity for GE Commercial Finance Real Estate, which recently bought Arden Realty, a Southern California office REIT, for $4.8 billion.