Commercial Real Estate Mergers & Acquisitions: Is it Only About Capital and Location?
Posted by Surabhi Sheth, Real Estate research leader, Deloitte Services LP, on March 19, 2014
Capital availability for U.S. commercial real estate (CRE) has increased gradually since the financial crisis. Per a 2013 Association of Foreign Investors in Real Estate (AFIRE) survey, 81 percent of respondents plan to increase their portfolio size in the United States. Closer to home, we are seeing non-traditional investors, such as hedge funds, acting as shadow lenders for properties in the secondary and tertiary markets, where bank loans are still hard to get. And then, real estate investment trusts (REITs) are flush with funds with the opening up of the equity and debt markets.
Not surprisingly, this has translated into an increase in CRE transactions (individual asset deals) and M&A activity (deals between entities holding CRE properties). In 2013, transaction activity increased 20.1 percent over 2012 to $359.4 billion1 and M&A activity rose 69.2 percent to $65.3 billion2. Real estate investors with healthy balance sheets and liquidity are now looking at the value offered by properties in non-prime markets when designing their portfolio and acquisition plans, given compressed cap rates for prime assets in primary markets. Companies are also considering different routes for investments — direct purchase, M&A (domestic and/or international) and/or sale and leaseback transactions — where traditionally, capital availability and property location have been key influencers of transaction decisions in the CRE sector. Take the case of the office and apartment property sectors that have posted large recent-deal volumes, primarily in the small-to-mid-sized segment, as more corporate entities are opting for deals to unlock value of their owned real estate and earn higher returns on their core businesses.
We are also seeing some other interesting trends in the CRE M&A landscape. For example, industrial property space has witnessed the marriage of large players. In contrast, in the retail real estate space, companies are taking the opposite route whereby a few large retail real estate players have spun-off a part of their business into a separate company. So, what is driving the disparate trends of consolidation and divestiture?
We believe CRE players are gradually moving away from basing decisions largely on capital availability and property location. Other transformational changes in the industry driven by tenant demand, use of technology and low development activity, are resulting in a shift in focus across asset types and towards operations. Hence, the industry is looking further into the future and considering deals, both acquisitions and divestitures, which take these elements into account and have the potential to create a sustained competitive advantage.
So, what approach should CRE companies adopt while assessing potential M&A and transaction activity? To begin with, CRE companies need to evaluate a range of activities, from focusing on the core to expanding the boundaries of their business. Further, companies need to move away from the traditional strategic approach, which has meant planning with a known view of the future. Rather, they should consider an iterative process using a scenario-based planning approach to reflect the dynamic business environment. It is important for companies to develop contingent strategies that are executed only when industry conditions manifest in a pre-determined scenario. For example, in a traditional set- up, an office real estate owner will consider property location, capitalization rate and available capital as some of the key evaluation criteria. However, given the changes in demand dynamics, it is now important for the same owner to consider and build in future implications of scenarios, such as the effect of increase in workplace flexibility on demand for physical space and/or other scenarios, in its decision-making process. Hence, as M&A activity is on the rise in the CRE sector and the rules of the game are changing, it always helps to try to be one step ahead of the broader market.
1Real Capital Analytics, February, 2014.
2Thomson Reuters, December 2013.
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