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Archstone Reaches Buyout Pact

Shares of apartment REITs jump on news of the record-setting deal.

Updated from 11:18 a.m. EDT

Archstone-Smith

(ASN)

, one of the country's largest apartment owners, agreed to be purchased by Tishman Speyer and

Lehman Brothers

(LEH)

in a deal valued at $22.2 billion.

The transaction marks the largest-ever privatization of a multifamily real estate investment trust.

Tishman and Lehman will pay $60.75 a share for Denver-based Archstone. The price represents a 23% premium to where the stock traded Thursday, the day before industry newsletter

REIT Wrap

published news of the possible takeover.

The $22 billion value includes the assumption of an unspecified amount of debt. Research firm SNL Financial values the equity portion of the deal at $15.2 billion, including preferred stock.

Archstone shares, which jumped 8% Friday, rose another $5.39, or 9.8%, to $60.62 Tuesday.

Shares of other apartment REITs also climbed after news of the buyout agreement.

AvalonBay

(AVB) - Get AvalonBay Communities, Inc. Report

jumped 7.3% to $127.61, while

Equity Residential

(EQR) - Get Equity Residential Report

rose 6.5% to $50.62.

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The Archstone deal signals that real estate in the public markets continues to be undervalued compared with what private-market players are willing to pay, says Dean Frankel, a portfolio manager with Urdang Securities Management, a real estate-dedicated investment firm that owns Archstone shares.

"You can argue that anyone here is worth a 20% premium to where their

stock price is right now," Frankel says about the REIT space.

Over the past few years, several smaller apartment REITs have been purchased by private-equity funds and other institutional investors.

In the past year, however, office and hotel buyouts have dominated the commercial real estate sector. The Archstone deal is the second-largest real estate privatization ever, lagging the $39 billion purchase of Equity Office Properties by Blackstone Group earlier this year.

"It could well be that this is the start of the next wave on the going-private side," says Keven Lindemann, director of the real estate group at SNL Financial. "There is plenty of capital out there."

Frankel points to Equity Residential as a particularly attractive apartment owner. The stock currently trades around $50, which implies the company's apartment assets are worth a 5.4% capitalization rate, or initial rate of return. That's too cheap, Frankel says.

The stock at $60 would reflect a 4.8% cap rate. (Cap rates move inversely to prices.)A firm like Blackstone Group, which is in the midst of raising an $11 billion real estate-focused fund, could easily buy Equity Residential and slice up the portfolio to sell individual assets at a 4.3% or 4.4% cap rate and book a nice profit, Frankel says.

The interesting question is whether the Archstone deal will give REITs a sustainable boost for the next few months. Prior to Tuesday, the MSCI US REIT Index was down 2.6% for the year on a total-return basis. The index had fallen 5.8% in May.

In early trading Tuesday, the REIT index rose 3.7%.

Much of the REIT correction was likely due to portfolio managers piling into the

S&P 500

, which has performed well, and shorting REITs.

Over the next few months, the REIT market should rally, and then will probably start to fall again, Frankel says. And of course, another large buyout deal down the road would send shares rallying again.

"If enough deals are announced, maybe hedge funds will stay away from shorting

REITs," Frankel says.

The Archstone transaction is being financed by equity provided by Tishman Speyer, with the balance of the debt and equity capital provided by Lehman Brothers and Bank of America.

Archstone CEO R. Scott Sellers agreed to an employment contract with the buyout group after the merger is completed.

"We have always been committed to maximizing value for our shareholders, and we believe this merger accomplishes that objective, offering a significant premium over the unaffected share price," Sellers said in a statement. "We are looking forward to continuing to provide great apartments and great service to our customers as part of the Tishman Speyer family, and continuing to grow our business for many years to come."

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