CHICAGO—Outperforming expectations and driven both by strategic and private capital, 2021 has already been a record year for REIT M&A, which hit $108 billion in transaction volume as of September 30, 2021. JLL’s Capital Markets M&A and Corporate Advisory group’s new M&A and Strategic Transactions Monitor report details the positive themes in the public capital markets space contributing to this M&A surge.
REITs have shown strong earnings growth in 2021, with 63 percent of REITs beating consensus FFO estimates in the second quarter of 2021. This has contributed to REITs outperforming the S&P 500 by 1,100 basis points thus far and REITs are among the best performing of the closely followed 11 Global Industry Classification Standard (“GICS”) sectors. Additionally, all major REIT sectors are in the green, with significant gains in previously out-of-favor sectors like retail (56 percent gain), office (15 percent gain) and hospitality (15 percent gain) for the year, while still showing positive performance in multi-housing and industrial. This has led to significant activity across both REIT M&A as well as broader commercial real estate transactions volume, which is on pace to reach 2019 level of approximately $80 billion.
“REIT M&A volume has broken a 15-year record that was set back in 2006,” said Steve Hentschel, head of the M&A and Corporate Advisory Group with JLL Capital Markets. “All major sectors contributed to the record, which implies a very favorable deal making environment for our sector. Confidence has returned, most REITs have strong currencies to use in strategic mergers, debt is historically cheap, and debt markets are liquid.”
The alternative asset classes—cold storage, data center, life sciences, manufactured housing communities, medical office buildings, self-storage, seniors housing, single-family rental, skilled nursing facilities, gaming, and student housing—are outpacing the traditional asset classes. At over 60 percent of the REIT sector’s equity market capitalization, the alternative REIT assets comprise most of the U.S. REIT universe today, and some of the largest domestic and international capital sources have made scaling alternative asset class holdings a priority. The appeal for the asset classes is broadly tied to the ability to generate higher average risk adjusted returns, given benefits of attractive in-place yield, lower capex requirements, and higher long-term NOI growth outlook. Hence, alternative sectors comprise approximately 10 percent of 2021 year-to-date transaction volume compared to approximately 6 percent in 2016.
“There is a significant demand and supply imbalance in the alternative asset classes, with high-quality platforms and assets generating strong interest from a wide array of investors,” JLL Managing Director Sheheryar Hafeez added. “We expect the trend to continue in 2021 and beyond, as fewer and fewer attractive opportunities are left to execute on.”
Today, a median REIT owns approximately $4.5 billion of real estate, which is more than four times higher than the size of a median REIT over the last two decades. The benefit of economies of scale has fueled larger REITs over time, as larger REITs have a favorable cost of capital advantage, given they can borrow debt and issue equity at a lower cost and are able to leverage their general and administrative overhead better given size.
“We looked at all major REIT IPOs priced over the last five years and noticed a positive correlation between size of the listed REIT and its relative performance one year following the listing,” Hafeez said. “This further supports the argument that bigger is generally better in REIT-land.”
Interestingly, even property sectors that have not recovered as much are experiencing robust transaction volume. For the first time since 2016, office REITs are on pace for more than $10 billion in acquisitions activity, driven in part by several office REITs executing strategic reviews, portfolio repositioning efforts, and expansion strategies. This surge in volume increases the share of total REIT transaction volume for the office sector for the first time since 2015. Furthermore, the sector has recovered to trade at pre-COVID net asset value (NAV) discounts, which occurs when the market price of the exchange-traded REIT is below the analyst estimates of the equity value of REITs’ real estate holdings. The narrowing of the gap in market price and NAV is a positive development for the office sector.
Additionally, inflation concerns are not anticipated to negatively affect REIT performance; in fact, inflation may drive positive performance. During the last 30 years or so, the U.S. economy has experienced five periods with similarly elevated inflation levels, and, being resilient performers, public REITs outperformed the broader market (S&P 500) four out of five times, with private real estate outperforming the S&P three out of five times. Though the impact of inflationary pressures is being watched, REITs are expected to continue to generate strong performance. Most of the REITs beat their consensus estimates in 2021 and REITs continue to be able to tap capital markets for growth, having raised approximately $60 billion in equity and unsecured debt capital in 2021 thus far.