The possibility of a private equity consortium gobbling up Sainsbury’s for an estimated £10bn has set the City alight with speculation. On the other side of Atlantic, however, a private equity deal makes Sainsbury’s look like small beer.
In February, Blackstone – which this week bought Tussauds, the London Eye and London Dungeon for $1bn – won the bidding war for the US real estate investment trust, Equity Office Properties, paying $39bn and completing the largest ever leveraged buyout. Even with today’s punchy sterling valuation against the dollar, that still translates into £20bn.
Rob Bould, head of capital markets at GVA Grimley, says: “The Blackstone acquisition of EOP is a step-change in the size of property deal that US private equity is prepared to make. It has blown everyone’s socks off.”
While the size of the deal may be hair-raising, Blackstone’s decision to acquire a property fund is not surprising: private investor interest in owning real estate assets has been growing in recent years. According to a report by Jones Lang LaSalle, US property assets worth $48bn were bought out by private finance during 2006.
Stephen Blank, senior fellow in finance at the Urban Land Institute, explains: “There are lots of private equity houses out there with significant amounts of cash that they need to invest. Property has performed extremely well over the past seven years and it provides a steady cashflow, which is a key criteria for private equity that needs to raise debt to complete acquisitions.”
For private equity to be interested in buying out a publicly-quoted REIT, there are a number of other criteria that need to be met: the stock price needs to have been lagging there has to be assets that can be sold to release equity and the management must want to exit the market. This can be the hardest factor to get right – management staff often own considerable stock options, which makes it harder for them to relinquish control.
Stock analysts disapprove of US REITs with debt equivalent to 50% or more of its market capitalisation, but private equity funds have no such qualms.
Blackstone has started to sell off some of the assets that it acquired with EOP, such as the office portfolio in New York and San Francisco. Private companies have no restrictions over the number of asset disposals in any given year, unlike REITs.
“Blackstone would have decided on those properties because they thought they could realise significant proceeds which could then be used to be to offset the cost of transactions,” says Blank.
Private investor interest in property mirrors the broader market. Last year was good for capital in-flows into property assets: global direct commercial property transactions reached $682bn, a surge of 38% over 2005 levels and an almost doubling of 2003 volumes, according to JLL.
The sale of EOP to Blackstone means that EOP’s investors have to find a new home for their cash. According to US newspaper reports, many investors are simply ploughing those funds straight back into US office REITs in the belief that, despite the incredible run of the past few years, there is still money to be made within the sector.
But those investors could equally look to re-invest their cash in a different sector or another country: investing in commercial property is increasingly a global pursuit. Investment where the purchaser or vendor – or both – originate from outside the country where the asset is located accounted for 42% of all investments last year – up from 34% in 2005, says JLL’s report.
The US and the UK are still the world’s largest commercial property markets, but their relative share is declining as investment into Germany and Japan grows. A significant driver in the growth of the number of transactions has been the sale of property assets. Investment in emerging markets also grew strongly with investment in Russia up by over 700% last year, admittedly from a low base, the report adds.
While US investors may well be looking to the UK, or even the rest of Europe, there are considerable differences between these markets. The modern era for US REITs began in 1991, with the offering of shares by Kimco Realty and over time, US REITs have become increasingly specialised. EOP, for example, does pretty much what it says on the tin – its funds are invested in office properties around the US.
In the UK and Europe, the REITs structure is just starting to be introduced. So far, nine companies have converted to REITs, including British Land, Hammerson, Land Securities and Liberty International, and those funds are invested in a broader spread of assets than their US counterparts. GVA Grimley’s Bould believes that the specialisation of the US REITs make them more attractive to private equity investors.
Bould thinks that private investors may find UK and European companies with significant property portfolios more attractive than UK REITs. Indeed, it is said that Sainsbury’s property portfolio is the asset of greatest interest to private equity investors. He thinks that they could be equally interested in utility companies given their sizeable property assets and steady cashflows.
Blank is not so sure: “While the private equity guys are clearly sharpening their pencils and trying to see whether there are other deals out there, I may not sure it makes sense to buy an industrial company just for its real estate.”
Blank sees Blackstone’s acquisition of EOP not so much as a step-change in the size of private equity property deals, but as a sign that the top of the market could be just around the corner.
“This deal was done at a very high price and it was the culmination of a number of transactions. There could quite easily be a couple of bolts from the blue that would make deals like this no longer add up. All it would take would be an event to impact interest rates or a shock to the market so that property values dropped substantially.”
