REIT IPO Investing

The real estate business is scoured by entrepreneurs big and small who purchase run down homes and buildings that they see as having resale potential. After spending some time and money fixing them up, these “real estate flippers” then sell their properties for sometimes substantially more money than they put into them.

Yet there is another group of entrepreneurs – with substantially more funds at their disposal – who do the same thing with real estate companies, finding private enterprises that own valuable real estate in homes, rental units, commercial buildings, and office spaces, which they revamp and resell to the public marketplace. I guess we’d call them “real estate company flippers.”

One such real estate company flipper – Blackstone Group LP (NYSE: BX) – just this past Tuesday took Brixmor Property Group public on the NYSE under the ticker symbol BRX. Holding the second largest portfolio of shopping malls in America, Brixmor raised $825 million from the sale of 41.25 million shares at $20 apiece, making it the second largest real estate IPO this year.

Brixmor was the first real estate company to be purchased and flipped by Blackstone Group, but it will by no means be the last, as the investment firm is one of the largest owners of real estate companies in the world and has plans to take the others public as well.

But why take a cash generator like Brixmor public, opting for a large cash payout now instead of a steady stream of revenue for years to come? Does this say something about the state of the real estate market? Even more pertinent to investors, does the practice of company flipping say something about the state of the IPO market?

From Land Rush to Land IPO Rush

The recent bonanza in the real estate market all started with extremely cheap property values in the aftermath of the 2008-09 housing crisis. Add ultra low interest rates that made property buying much too opportune to pass up, and you have one of the greatest land rushes in decades.

But more than just families were rushing in to snap up great deals on real estate. Real estate companies also moved in, snapping up as many homes, rental units, and commercial properties as they could finance.

Yet the rush didn’t end there. As real estate companies built up their portfolios of properties with impressive revenue streams, investment companies then rushed in to snap up the real estate companies, all with the intention of taking them public when the time was right.

2013 seems to be that right time, with publicly traded real estate REITs trading at multi-year highs near their pre-housing crisis peaks. Investment firms like Blackstone Group who own real estate companies are finding it prime time to devest themselves of their holdings, as the real estate rush turns into a real estate IPO rush.

Real estate investment trusts (REITs) and other property-related IPOs – from commercial buildings to office towers to hotels to real estate management companies to mortgage trusts to realtor agencies – have already raised $4.7 billion going public in 2013, the most since 2004, shortly before the last housing bubble reached its maximum girth.

“It’s a great time to sell,” Anthony Breault, senior real estate investment officer for Oregon State’s pension fund, assessed to Bloomberg. “Leasing is back up and there’s a froth of demand for income-producing assets,” he reports, as his pension fund enjoys the most income from its private real estate investments since the height of the last bubble in 2007.

Private real estate companies have certainly built up some impressive cash generating property holdings. But isn’t this what every owner of a real estate company wants? A steady stream of cash pouring in? Then why are so many dumping their real estate holdings onto the public market through IPOs?

Is the Real Estate Market Cresting?

One indication that the housing market might be overheating yet again is the remarkable comeback in REIT funds and indices, such as the Vanguard REIT Index Fund, which has seen a jump of 231% from its 2009 post-housing market implosion low all the way back up to its 2007 pre-property bubble levels.

In May of this year, however, it and other REIT funds have been falling some. By what cause? The Federal Reserve’s announcement that it was considering reducing its purchases of bonds and mortgage-backed securities. In anticipation of those stimulus reductions – which would in turn be closely followed by rising interest rates – investors dumped bonds, which drove yields and mortgage rates higher.

As the increased cost of borrowing began cooling the housing market, real estate companies began realizing that we may be at or near a short-term housing peak. Of course, the real estate market will continue to grow even after interest rates begin rising in 2015 or so, just not at such a brisk pace as we have seen lately. So the time for real estate companies to quietly head for the exits and leave this house-warming party is probably nigh.

Harris Trifon, head of commercial real estate debt research at New York’s Deutsche Bank AG, voiced the industry’s concern to Bloomberg, “We’ve benefited a lot from the return of capital and the financing environment and liquidity and if anything disrupts that [ie: less Fed buying of mortgage-back securities followed by higher interest rates], that would cause a major problem.” Though he is not expecting such disruptions for now.

But the company behind the latest real estate REIT to go public certainly seems to be. Fresh on the heels of yesterday’s offering of Brixmor, Blackstone Group is already preparing to take its famous hotel chain Hilton Worldwide Holdings Inc. public this December. Are they getting out while the getting is still good?

Should You Bail Out of Real Estate?

Despite recent fears of disruptions to the real estate market, Karagosian Financial sounded optimistic in its letter to investors:

“The landscape for equities and real estate remain the most attractive, in our view,” the firm specified in its October 28^th release. “Low interest rates allow companies to borrow cheaply and expand or renovate existing facilities. However, with the strong run-up in both asset classes the past year, we would characterize the stock market and real estate market as fairly priced.”

With talk of stimulus reductions on hold for the time being, and bond yields having come back down recently, real estate companies and investment trusts could still be viable investment options for a while longer.

Even so, Karagosian does admit the lowest hanging fruit has already been harvested. “We think through careful selection we can still find some good value, but it is certainly more difficult,” the firm stressed in its letter.

Looking at some recent IPOs in the real estate space, investors certainly need to be selective. Bloomberg showed that out of the 14 real estate IPOs this year, nine are trading higher than their offering prices, while five are down – more than a third.

As we sift through the choices, we might want to stick with those giants in the space that are assured to have a long future ahead of them even when interest rates start to rise again. People will always buy homes, and realtors like RE/MAX (NYSE: RMAX) will always be in demand. Ranked number one in the U.S. in home sales, RMAX’s October IPO has already gained 6.3% over its opening trade.

And companies will always need office space, especially in New York City, where Empire State Realty Trust (NYSE: ESRT) owns 21 properties ranging from office towers to commercial buildings – including the famous Empire State Building. ESRT’s October IPO has, for its part, gained 8.5% over its opening trade.

But perhaps the better deal might be to join forces with the sellers, not the buyers. After all, Blackstone Group knows the real estate business well enough to drive its stock from $11 in the middle of 2012 to some $27.50 now – an appreciation of 149% in 18 months. Plus, it is paying a comfortable 3.35% annual dividend yield.

With several IPOs waiting in the wings, Blackstone Group would likely be a more secure holding than its spinoffs, since the seller usually gets the better deal in these things. At least two more Blackstone companies are expected to be sold on the public markets in 2014, including: IndCor, a warehousing operation in Chicago, and Invitation Homes, a single-family home rental business of 40,000 properties in the Dallas area.

“Blackstone’s got a lot of equity to sell over the next several years,” Joe Smith, co-chief investment officer of CBRE Clarion Securities, emphasised to Bloomberg. And while IPOs can sometimes work out well for investors, they almost always work out better for the sellers.

Joseph Cafariello

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