Investors Can Still Compete With REITs
Industry scuttlebutt these days often frames real estate investment trusts as over-funded steamrollers, driving little guys out of the market. Sellers have a friendlier view of such big spenders, of course, but market observers say private investors can still compete with REITs.
What’s crucial to note, observers say, is that Southern California has changed dramatically for private investors, who pretty much had their way during the recession, when real commercial real estate wasn’t on many “buy” lists.
Today, publicly held REITs clearly have a competitive advantage in raising money to buy commercial properties, because they can issue stock and their size enables them to borrow from banks at some of the lowest interest rates available, said real estate attorney Richard Kale of Greenberg Glusker Fields Claman & Machtinger.
“There are some private investors with huge net worths who can probably go to a bank and do as well, but those are very rare,” Kale said.
Because issuing stock and taking on corporate debt are both less expensive ways of raising money than the interest rates most private investors must pay to raise capital, REITs can afford to accept lower returns on properties, which means, in turn, they can afford to pay more for those properties, Kale explained.
But are these advantages really driving some private investors out of the market--or will they in the future? And are REITs really overpaying for some properties, as competing investors charge?
“We are in escrow right now on three deals that REITs were interested in, but we’re the ones who are doing the deals,” said Steve Ohren, president of Marina del Rey-based Pacifica Capital Group, a private investment firm that buys properties through limited partnerships and has more than $700 million in holdings in California and Colorado.
Ohren said Pacifica’s winning the deals, each of them in the $10- million range, means that private investors can still compete with REITs, although he adds that this might not be true in a year or two.
“There is no question that the REITs are dramatically changing the nature of our business, and some players may already have been driven out, but these things take time to happen, and we feel that entrepreneurs still have certain advantages over big organizations like REITs,” Ohren said.
As for stories of REITs overpaying for some properties, Harvey Green said he’s looked into some of the tales and usually finds that the REIT had a solid reason for paying a premium price.
“The REITs aren’t stupid,” said Green, an executive vice president with Marcus & Millichap Real Estate Investment Brokerage Co. in Encino. “These are companies who do sophisticated financial analyses. They aren’t just out there aimlessly acquiring real estate.”
Ohren and Jack Mahoney, president of El Segundo-based Summit Commercial Properties Inc., both referred to “flying under the radar” of REITs to buy properties smaller than those in the so-called REIT range of $10 million and up, although both sometimes go after larger properties.
“We find that the easiest way to compete against the REITs is to buy buildings smaller than the ones they’re interested in,” Ohren said. Most of Pacifica Capital’s deals are worth less than $5 million, he said.
According to Mahoney, fear of big, cash-rich investment firms such as REITs is a recurring refrain in commercial real estate.
“Ever since I started in the real estate business, I’ve heard that the big institutions were going to squeeze the small players out. When I first started, it was the pension funds,” Mahoney said.
Private investment firms can still compete against REITs because the private firms can usually make decisions faster and close deals more quickly, said Mahoney, who said REITs are like the proverbial big battleship that takes a long time to change course.
Tyler Rose, a senior vice president at Kilroy Realty Corp., an El Segundo-based REIT, agreed.
“I think it’s absolutely true that it’s harder for big REITs to compete on smaller properties,” Rose said. “It’s a better allocation of our resources to focus on large transactions.”
Kilroy’s average transaction size ranges from $10 million to $15 million. The firm is buying office and industrial properties throughout Southern California, but Rose isn’t buying the suggestion that REITs may be shutting some investors out of the market.
“The Southern California market is so huge that there’s room for everyone to play. There are lots of deals out there, and regardless of whether the REITs find them or other buyers find them, there’s plenty of property out there to be purchased, and I don’t think anybody is really shut out of the market,” Rose said.
Rose added that private investors have an advantage over REITs because private firms don’t face pressure from Wall Street to increase earnings every quarter.
Private investors’ fear of competition with REITs also has to do with the size of the deals, said H. Bruce Hanes of Westlake Village-based Hanes Investment Realty Inc. He said he typically buys properties priced at $1 million to $5 million for a family trust, but that “REITs buy trophy properties.”
Green of Marcus & Millichap said REITs tend toward the top of the market because they “aren’t interested in a situation where it takes a lot of elbow grease to make the property work, whereas an individual private investor can go in, add value, and then sell the property to the REIT.”
Another reason private investors can remain competitive, according to Ohren, is that sellers aren’t always interested in an open bidding process if they can get a good price from a buyer they know.
“We have a strong network of relationships in the brokerage community and very strong financial resources, so we get opportunities that people bring to us because they’ve known us for 20 years,” Ohren said.
A more far-reaching effect of the REIT phenomenon, according to Ohren, may be that values in the Southern California commercial real estate market may top out much faster than they would have in earlier eras.
“I think the real estate cycle this time may be shorter and more severe,” Ohren said. “What might have taken 10 years without the REITs might happen in five or four or two years.”
Mahoney believes one of the next big surges in Southern California will be by big East Coast REITs that buy shopping centers.
That could turn Summit from a buyer to a seller, he said, although the company has bought more than $400 million worth of grocery-store-anchored neighborhood shopping centers in the last year.
Most REITs are still buyers in today’s market, but Green believes some REITs will have to become sellers because bidding against other REITs will become too expensive. It already happened last month, he noted, when Sam Zell’s Equity Office Properties Trust agreed to buy Beacon Properties Corp., joining two of the nation’s largest property owners and REITS.
