Crisis will force private real estate to go public

Tight credit conditions in the US will diminish the private sector’s monopoly on residential and commercial property, driving assets into public markets and real estate investment trusts (REITs) loaded with cash from a spate of capital raisings.

In the four years preceding the market meltdown, REITs were net sellers of property assets to private equity funds thriving on cheap debt. But this momentum has reversed as public markets have become a more affordable source of capital in a credit-crunched world.

Todd Briddell, chief investment officer of Urdang, a global REIT manager within the BNY Mellon stable, says REITs will favour the less debt-ridden assets flowing from the private arena.

“The market is shaping up for a re-emergence of the REIT market worldwide,” Briddell says.

“Public markets haven’t supported high levels of debt but private equity has. In a less-levered world, REITs which favour less-levered balance sheets will be at a competitive advantage relative to highly levered private equity.”

He says as much as 92 per cent of the US real estate market is owned by private equity managers or held in other arrangements among institutional investors, following a glut of deals that peaked in 2004-05 and continued right up until 2007.

The surge of capital raisings undertaken by REIT managers this year had repaired balance sheets and, for some, provided a foundation upon which future raisings can be conducted to fund acquisitions.

“Management teams are going to preserve their liquidity as a show of strength in order to issue new equity for future acquisitions. It’s show money.”

But since credit spreads will continue to increase, making debt expensive and encouraging companies to keep cutting leverage, future acquisitions will be done with greater volumes of company stock.

“Expect bond holders to be ultimately paid off with equity in public REITs. That’s what happened in the early 1990s recovery.”

In Asia, a fast-growing REIT market led by China, public ownership of property through listed markets is becoming more widespread because foreign investors prefer this arrangement over direct acquisitions.

Primarily accessed through Hong Kong-based property companies, the Chinese real estate market presents many opportunities, Briddell says. But its growth will not follow a smooth trajectory, and government policies can have the effect of either encouraging or discouraging investment.

“A market with the momentum of China will always have periods of over-building. Also, the stimulus policies are subject to change, and so might be the reporting of economic growth, so we’re all learning how to think through the China opportunity.”

Taking a macro view of global markets, Briddell says government policies have become “the big X-factor” shaping future investment strategies, since stimulus spending has become a strong and sudden force influencing capital markets and economic fundamentals.

For example, how the US manages its budget and debt problems will affect the strength of its market and currency, he says.