5 REITs Ripe For Buyout

M&A has been shown to be a mixed bag for the buyer. Sometimes, there is huge synergy and other times it is just the CEO wanting to manage a bigger company. However, it is almost universally a good deal for shareholders of the target. Buyout premiums are often 10%-50% over pre-announcement share price of the target. It is one of the fastest ways to realize the fair value of a discounted investment.

The key is to spot and own companies prior to the buyout announcement. We at 2^nd Market Capital have been beneficiaries of dozens of companies getting bought out. Over the years, we have identified certain features that increase the chances of favorable M&A. Specifically, the following 6 increase the chance of a company getting bought:

1. Discount to NAV
2. Valuation disparity
3. Hot asset type
4. Property overlap with buyer
5. Willing to sell
6. Low-hanging fruit

The more of these features a company has, the higher the chances.

Discount To NAV

REITs are cheaper than normal right now. The median equity REIT trades at 86.4% of net asset value (NAV). As such, the sector as a whole is primed for slightly increased buyout activity, but there is a substantial dispersion of value within REITs. They range from Hudson Pacific (HPP) at 31.1% of NAV to Welltower (WELL) at 200% of NAV.

Discount to NAV serves as the primary financial incentive for a buyout. Getting to buy a company for less than the value of its properties can create immediate accretion. The bigger the discount, the more value to be gained. Here are the 5 most discounted REITs.

While the severe discount makes these potential M&A targets, there is more to it than that.

Cheapness alone is not enough to inspire a buyer, and blindly buying discounts to NAV can be a dangerous strategy. We previously discussed the dangers of Peakstone.

Note that the companies above are overwhelmingly in office, which will come into play as we discuss valuation disparity and asset class desirability.

Valuation Disparity

In order for buying discounted assets to be accretive, the buyer has to have good currency. If the buyer is just as discounted to NAV and uses their stock to finance the merger, there is no accretion.

In the case of offices, such as the companies shown above, the median office REIT trades at 74% of NAV. Thus, if a peer office REIT were to buy one of these heavily discounted office REITs, they would be issuing equity at a loss to their own value (74 cents on the dollar). This would greatly reduce the net NAV accretion of the purchase.

So it is not just that M&A targets have to be discounted in absolute terms, but they also need to be significantly discounted relative to the entities that would potentially buy them.

Back in September 2023, we wrote about Tricon Residential as a buyout target.

The deep discount at which TCN trades makes it an attractive target for the private equity that is scooping up SFR.

I thought the buyer was going to be Pretium, but it ended up being Blackstone that bought Tricon Residential.

Private equity was raising capital at essentially 100% of NAV, which made the delta between their cost of capital and the substantial discount at which TCN traded highly accretive. The buyout was also driven by single-family rentals being an in-demand asset class.

Hot Asset Type

While larger discounts often do and should appear in disfavored asset classes, M&A is far more likely to occur in property types to which companies want to increase their exposure.

There used to be half a dozen data center REITs, but then Switch got bought, Cyrus One got bought and CoreSite got bought. The sector is down to 2 and a half names with just pure-plays Equinix (EQIX), and Digital Realty Trust (DLR) along with partial exposure from Iron Mountain (IRM). Each of these is very large and trading at a premium, so further M&A in data centers is less likely, but we can learn from what happened.

Shopping centers are quickly becoming a hot asset class. Private real estate markets already see the strength of retail, with large companies like Blackstone buying up quite a bit of shopping center real estate. The public REIT stock market has been slower to catch on to the strength, leaving many of the shopping center REITs at significant discounts to NAV.

Saul Centers trades at 71.5% of NAV despite having an impressive asset portfolio. One of the larger REITs like Kimco Realty (KIM) or Federal Realty Investment Trust (FRT) could buy Saul very accretively.

Whitestone REIT (WSR) has already been the target of M&A twice but has refused those offers on the grounds of too low of an offer price. This brings us to the next key aspect of buyout targets.

Willingness To Sell

If you ask a management team whether or not they would be willing to sell the company if a buyout offer came along, the most common answer will be something along the lines of:

That would be a board decision, but of course we will consider any offers that come in.

We have asked this question to dozens of management teams and by my estimation, at least 70% gave an answer equivalent to the above. This is the stock answer that keeps all of a company’s options open.

Occasionally, however, there will be little hints that certain companies are more or less willing to sell than others. It could be inflection in their voice or phrasing, but usually, one can get a sense of the degree of willingness to sell. Companies are good about not violating Reg FD, so if they are going to give a more direct answer, they often do it on earnings calls, which are automatically deemed public information.

Paul Pittman of Farmland Partners (FPI) will discuss on conference calls how much stock he has in the company and how much he would personally benefit financially from a sale of the company at closer to fair value.

Beyond what management says, there are other factors that influence how ready a company is to be bought:

1. Poison pill or lack thereof
2. Golden parachutes
3. Activist shareholders and the manner in which management engages them
4. Entrenchment clauses in contracts or lack thereof
5. Age of executives (are they looking to retire?)

If a company is willing to sell, the validity of M&A is influenced by synergy as well as the going-in valuations of buyer and seller.

Synergies

Low-hanging fruit is technically a bad thing. A poorly run company is likely under-earning its potential and if it continues to be run poorly it could underperform. However, this low-hanging fruit also represents an opportunity for the buyer.

The self-storage industry is among the most fragmented with many of the smaller operators running inefficiently, whether it is due to not enough scale or simply not having the real estate expertise to maximize profits. For decades M&A was rampant in self-storage, with the buyers able to almost instantly improve operations and make the deals far more accretive than the numbers alone would indicate.

Publicly traded companies are under enough scrutiny that low-hanging fruit is a bit less prevalent, but it still exists, most often in the form of being subscale. Simply existing as a publicly traded company costs somewhere around $3 million a year. That is an overhead cost that can be almost entirely eliminated by consolidating 2 companies into 1.

Property-level operating expense or opex works similarly in that regional property management offices have lower overhead per property if they service more properties. As such, M&A is more likely to happen if two companies have overlapping property maps.

BSR REIT (OTCPK:BSRTF) is a great example of potential savings on both company overhead and property overlap. They own apartments in key Texas submarkets in which larger REITs already have exposure and want more.

Opex and G&A savings would make a buyout of BSRTF even more accretive than the NAV discount already presents.

Top 5 REIT Buyout Opportunities

One can never know the future, but analyzing the above factors provides insight into which companies are better positioned to be the target of M&A. Here are 5 REITs that, we think, are substantially more likely than most to be bought out at significant premiums to current share price.

In the table below, we grade each of these REITs on each of the key M&A drivers.

Overall, I think these are 5 of the REITs most likely to get bought out at substantial premiums to today’s price.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.