The year 2017 has seen signiﬁcant NAV discounts emerge in pockets of the market. And, with major private equity (PE) funds and large institutions awash with capital, a handful of public-to-private transactions have occurred. Multibillion-dollar transactions have seen ofﬁce and residential REITs taken private by a mix of capital sources, including both PE and major pension funds.
While the relatively mature nature of this real estate cycle means investors continue to display a degree of caution, we believe that selective public-to-private transactions will occur where obvious synergies exist. This is in contrast to previous cycles, in which market-wide opportunities existed as a result of the availability of cheap capital.
Tax legislation remains a fundamental requirement to create an effective REIT market …
Tax legislation continues to evolve across all REIT markets and particularly in nascent jurisdictions where a broad REIT framework exists, but is not practicably favorable enough to see companies convert or go public. REIT industry groups from around the world have been actively exploring ways to reﬁne their existing legislation to make them more attractive and provide the type of tax incentives to further promote the use of the REIT structure.
In many instances, real estate investors (individuals, PE and companies) have been willing to accept a heightened degree of tax complexity to beneﬁt from these vehicles and to defer taxation upon disposition (e.g., through like-kind exchanges and other strategies).
While the debate concerning the exact nature of the changes to US tax reform is ongoing, a signiﬁcant reduction in corporate tax rates and certain income from partnerships that is currently proposed could affect decision-making related to the type of investment vehicle chosen by real estate owners.
For existing US REITS, once there is more clarity as to potential changes in US tax law, management teams will need to evaluate the resulting impact on taxable income, and cash flows and dividend yields, as well as on the opportunity for tap deferral planning. These issues are central to the valuation of real estate ownership, and operations and capital allocation decisions.
… and legal and tax issues continue to influence the structure of REITs across different markets …
The unique nature of legal and tax jurisdictions means there continues to be a wide discrepancy in what REITs look like in different regimes. As a result, issues that may appear resolved for some may remain very relevant for others. One such area is the decision to operate with an internal or external management structure.
Globally, 38% of REITs by number are externally managed, partly because in markets, such as Japan, they are required to be, whereas others, such as Singapore, choose to be. Even in markets, such as the US, where, for many, this issue has long been resolved, we are seeing better structures that overcome historic fee and alignment issues; these have reinvigorated the non-traded REIT market. This concept may be increasingly of interest to other non-US REIT markets.
… while all types of investors push for greater adoption of best practices
Universal acceptance of best practices in terms of structure, corporate governance, financing and capital allocation is rarely achievable. But, recent years have seen a more vocal group of activist investors pushing for change when they identify issues in these areas that they consider to be suboptimal. Our analysis of two-and-a-half years of REIT shareholder activism in the US suggests that shareholder rights, corporate governance, management structure, alternative strategies and strategic direction form the basis of most activists’ concerns. This is because not all campaigns have been initiated against companies that have underperformed against their peer group.
The rise of activist investors in the US has also coincided with a greater focus globally on corporate governance. REIT investors are increasingly challenging organizations around corporate governance, with board composition, transparency, accountability, diversity, experience and alignment seen as essential elements of good governance. Our article on investor activism in the REIT sector highlights business areas and issues being targeted, and considers how companies can view themselves through the lens of a shareholder group in order to identify areas for improvement.
While public activism, as seen in the US, has yet to become commonplace globally, the themes and issues raised by activists provide a valuable reminder of the focus of REIT stakeholders.
Many of the US activism themes are, therefore, directly applicable across all REIT markets.
Technology is accelerating the pace of change and contributing to a more dynamic and fast-moving real estate market
Technology will continue to create both challenges and enormous opportunities, and it is not just about disruption. Technology will help the real estate industry design more sustainable buildings, making better use of water and energy resources. Reduced operating costs and better safety features should result.
It will also help real estate owners better understand the standing of specific assets within a certain submarket, enhancing their ability to make informed buy, hold or sell decisions. Technology will also be highly disruptive, however, in fundamentally redesigning the way tenants in all industries use real estate. This is challenging management teams to stay abreast of trends that evolve rapidly.
For those unable to keep pace, the risk of asset obsolescence is very real, with negative implications for portfolio value and the business generally. The accelerated pace of change seen in our markets makes obsolescence more relevant than ever before. Investors, lenders and rating agencies are considering these factors as part of their process in determining how to underwrite companies and their real estate assets.
This may have future implications for a key REIT financing mechanism, affecting both an organization’s ability to access debt financing as well as the pricing of that debt.