Managers are exploiting the mismatch in realty markets

Institutional real estate money managers are taking advantage of a mismatch between the private and public realty markets by moving between them in a quest to boost returns.

Fueling the trend is that in some cases, real estate portfolios are worth more than the companies that own them. The pricing disparity led to about $15 billion in transactions last year, and more are expected in 2006, real estate consultants and money managers say.

This development reflects institutional investors' search for alternate ways to invest their real estate allocations and to increase returns. They have done this largely by buying interests in real estate operating companies, mainly real estate investment trusts.

According to Chadwick, Saylor & Co. Inc., a Los Angeles-based consulting firm, core real estate — existing, leased institutional-grade property — will return between 7% and 9% this year, while returns from acquiring positions in real estate companies could be between 13% and 15%. That is why investors are straying from their traditional method of investing in real estate funds and individual properties.

The public-to-private or private-to-public routes are becoming increasingly popular ways of making a profit.

Public real estate firms have been moving to private mainly through acquisition or merger with a private real estate firm, which buys out the shareholders and de-lists the companies. Private real estate firms go public through an initial public offering.

"The private and public (real estate) markets are out of sync," said Bruce Schonbraun, managing partner of the Schonbraun McCann Group, New York, a real estate financial consulting firm. These days, the underlying value of the real estate is greater than the value of the public company's stock, Mr. Schonbraun said. Plus, private real estate is valued below REIT shares for some property types, he said.

In short, the sum of the parts is valued more than the whole.

Similar moves between public and private last occurred in the early 1990s, when cheap debt fueled the conversions. But most of the recent deals have been nearly all cash, funded by the massive amounts of capital available to invest in real estate, Mr. Schonbraun said.

"There is a lot of equity available because allocations to real estate have been increasing," and institutions are looking at public real estate companies, which they hadn't done before, he said.

Public REITs that have been, or are being, sold and taken private include:

• Bedford Property Investors Inc., Lafayette, Calif.,a self-administered REIT with investments in suburban office buildings and industrial properties, which signed a merger agreement Feb. 10 with real estate investment manager LBA Realty LLC, and plans to go private;

• Gable Residential Trust, Atlanta, a public REIT that went private in September after being purchased for $3 billion by ING Clarion Partners and a group of institutional investors;

• Centerpoint Properties Trust, Oak Brook Ill., a REIT being sold to CalEast Industrial Investors LLC, La Salle Investment Management Inc. and Solstice Merger Trust, a new REIT that is a subsidiary of CalEast. Cal East is majority owned by the $204.2 billion California Public Employees' Retirement System, Sacramento.

• Arlen Realty , Los Angeles, an office REIT being purchased for $3.2 billion by General Electric Capital Corp. and Trizec Properties Inc.

• Town & Country Trust, Baltimore, which is the subject of a bidding war between an investment group led by Morgan Stanley, Onex Corp. and Sawyer Realty Holdings LLC and a consortium led by Essex Property Trust Inc.; and

• CRT Properties, Boca Raton, Fla., an office REIT purchased by DRA Pension Advisors.

DRA's purchase of Capital Automotive REIT is pending.

Firms embracing the public market include GSC Capital Corp., New York, which plans to take its REIT public, according to regulatory filings, and Douglas Emmett & Co., a Santa Monica, Calif., private real estate firm that plans to go public this year.

"If you look from the standpoint of the seller like Arden Realty and their shareholders and directors … pricing is significantly better than it has been in the last 20 years," said William J. Chadwick, managing director of Chadwick, Saylor. "Why not take advantage of higher pricing?"

What's more, legal changes such as the Sarbanes-Oxley corporate reform act have made public companies unattractive, said Russ Appel, president of real estate investment manager Praedium Group LLC, New York.

Being a public company is "expensive and a hassle," said Paul Saylor, managing director of Chadwick Saylor. "Executives are tired of managing quarterly earnings, and a lot of these people have made a lot of money. It's a trend that will continue."

Executives of private REITs and operating companies also are looking at going public as a financing tool, a way to pay back investors and create an exit vehicle for founders looking to retire, Mr. Chadwick said.

"Existing management has been running (the REITs) now for many years," said Praedium's Mr. Appel. "They are aging and it's one way to get their money out or to work out estate issues." In the past decade, Mr. Appel said, a lot of REITs went public to pay off their debt issues.

Another increasingly popular reason for taking public companies private is that private company returns can be higher than returns on public companies, Mr. Chadwick said.

Private companies can take advantage of cheap debt more readily than the public companies, Mr. Appel said. Higher debt levels bump up returns, but public markets implicitly restrain the amount of debt public companies use, he said.

Returns are also calculated differently for the two markets: Returns on private investments are based on total return over time; public REITs trade on current cash flow.

A few REITs have flipped back and forth a few times. General Growth Properties Inc., a regional shopping center REIT based in Chicago, has made the switch twice during its 50-year history, going from private to public and back to private again. Investors and joint venture partners in General Growth include the $34.9 billion Illinois Teachers' Retirement System, Springfield, and the $131.9 billion New York State Common Retirement Fund, Albany.

"It's mostly arbitrage," Mr. Chadwick said. "There's always a spread between public and private pricing and if the spread is material, they will always do it."

Some institutions are investing in existing public and private real estate companies in addition to partnering with them to purchase large portfolios, Mr. Saylor said.

Just last week, the $51 billion defined benefit plan of the State of Michigan Retirement System Fund, Lansing, agreed to sell half of its controlling ownership interest in Simpson Housing Limited Partnership LLP, a Denver real estate investment firm, to the $31.6 billion Alaska Permanent Fund, Juneau, said Michael Burns, Alaska Permanent's executive director. The $2.1 billion deal is expected to close March 31.

The Michigan fund owned about 95% of Simpson Housing, a large private multifamily development and operating company. Alaska Permanent's purchase was a way of buying an entity with a large real estate deal flow, rather than buying one parcel of property at a time, he said.

The deal is not without precedent. Cadim, Montreal, the real estate unit of the C$122.2 billion Caisse de Depot et Placement du Quebec, is a major shareholder of The Praedium Group, which has $3 billion under management.

"Investors are starting to think a little more creatively in deploying capital," said Mr. Saylor, whose firm advised Alaska on the Simpson deal.

Praedium's Mr. Appel said all the switching could be a short-term trend. Over time, more private companies will go public to appeal to the growing number of defined contribution plans, he said. "As pension capital shifts from defined benefit to defined contribution, having a daily mark to market of a public vehicle will attract more capital over a longer period."