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2008 could well see a pipeline of M&A activity in the UK real estate sector, dealmakers said this week.
With many property stocks trading at large discounts to net asset value, speculation has been rife that companies in the sector could be takeover targets in the near future.
A banker with knowledge of the real estate industry said that, having fallen hard, many UK property companies now looked good value and were attracting a great deal of interest. “There are people running serious numbers on serious players,” he said, predicting strategic deals motivated by the correction in underlying physical real estate values. A second banker agreed that suitors were likely actively considering property deals because of the seemingly cheap stock.
But deals would not occur simply because assets looked cheap, a third banker countered. Describing the takeover chatter as “a bit overdone”, this banker cited the credit freeze as the main obstacle to deal activity. He said there was no evidence banks would finance real estate deals.
A fourth banker concurred, saying: “A lot of people are talking about big discounts but life doesn’t work like that. There are two currencies in real estate--equity and debt. Business is closed on the debt side.”
A fifth banker agreed that the lack of debt could continue to act as a brake on activity. He said: “If it wasn’t for the difficulties in the credit market, there’s no doubt we would have seen activity. There is no shortage of equity out there but, if anything, access to debt is getting more difficult.”
While he acknowledged that credit conditions would need to thaw somewhat, the first banker did not view the lack of debt as an insurmountable obstacle. He noted that there were companies in the market with unused credit lines, which could do deals with a combination of cash and shares. One such company is British Land, the UK-listed REIT, which announced Thursday it had GBP 2bn of committed undrawn bank lines available to spend as opportunities arise, although British Land CEO Stephen Hester said in a conference call that he did not anticipate significant M&A activity in the UK property sector in the short-term.
Meanwhile, a sixth sector banker said that “people were finding ways to get around” the credit difficulties. The first banker pointed out that there were active balance sheet lenders who were still in business. He also commented that real estate deals tended to be financed with less debt than buyouts in other sectors and that lower geared structured made better sense. This would mean that companies with cleaner balance sheets on the debt side could be feasible targets.
A further obstacle on the path to activity, however, could be the difficulty faced by investors in determining value. “None of us believe these companies are trading at 30% discounts,” the fifth banker commented. ”We need to see transparency with values. Once the real values are known, things will be clearer. I expect companies will be trading at discounts but more modest ones than at the moment.”
This banker considered British Land’s third quarter results, announced Thursday, to be a significant milestone because they would set a benchmark for the sector. The UK property giant said it had written GBP 1.39bn off the value of its assets in the third quarter, causing its net asset value per share to drop 16.7% to GBP 14.01.
The first banker agreed that British Land was a “bell cow” and that it would be important to see how the market responded to its results. British Land shares rose 17 pence to GBP 9.79 in opening trading Thursday but dropped back down to GBP 9.62 in the afternoon.
Further real estate companies are due to announce results in the coming weeks, most notably Hammerson and Liberty, the UK REITs.
Asked what the catalyst for M&A activity in the property sector could be, the fifth banker said that it would take a deal to unleash a chain of events, as Blackstone’s acquisition of Equity Office Properties had in the US market last year. The banker said he thought the planned demerger of Land Securities could prove to be the ice-breaker. A source close to the company said Land Securities was preparing to listen to offers for its businesses. The first banker speculated that Trillium, Land Securities’ property outsourcing business, could be a good fit for Mapeley, the UK-listed outsourcing company in which Fortress has a 50% stake.
The second banker said it was difficult to predict which companies could be sold first but tipped Capital & Regional, Minerva and Great Portland Estates as likely candidates.
Meanwhile, the fifth banker said it was possible to make a case for and against all of the major UK REITS being sold. The banker said: “Morgan Stanley has 11% in Hammerson and doesn’t stay inactive for long. There are rumours about British Land. Segro needs to do something with the cash from the sale of its US portfolio or someone will do it for them. Liberty is the most or least vulnerable depending how you look at it.”
This banker also considered it useful to analyse the industry by sector, saying: “West End office have appeal, meaning companies like Great Portland Estates (GPE) could be vulnerable. They have more appeal than companies with City exposure or with operations in the logistics sector, such as Segro and Brixton.”
The banker added that the dynamics were in place for the UK to embark on REIT consolidation, as had already occurred in more mature REIT markets. Meanwhile, the first banker said intra-REIT mergers could occur but would have to be friendly and consensual. Also, he pointed out, the investors were often the same across different REITS and they would have to see obvious value in any eventual merger.
Take-privates of REITs could also occur, although there has been a degree of uncertainty in the market due to ambiguities in UK legislation with regards to a REIT exiting the REIT regime. The uncertainty surrounds the question of whether the government could then rewrite the tax history of the company. The fifth banker said he was seeking clarification from the Treasury on whether, if a REIT lost its status, the government would claw back the capital gain benefit. This scenario is as yet untested but, if it were the case, it could be used as a takeover defence mechanism.
However, a regulatory source said HM Revenue & Customs (HMRC’s) clarified its position in a meeting with various industry parties last week and planned to communicate its stance to the market in the coming weeks. The source said the HMRC had said it had no problem with genuine third party takeovers and would not seek to rewrite a company’s tax history if that was the case.
If take-privates were to take place, sovereign wealth funds have been speculated as potential bidders for UK real estate assets. GIC, the Singapore fund, already has stakes in British Land, Brixton and Great Portland Estates but has a reputation as a passive investor.
The bankers were divided on the intentions of sovereign wealth funds. On the subject of GIC, the fifth banker said: “They see this as an opportunity to put capital into the market in a transparent, liquid form. I’d be surprised to see the sovereign wealth funds doing anything aggressive.” The first banker, however, pointed out that Investment Corporation of Dubai (ICD) was interested in Colonial, the Spanish property group.
The first banker said a host of “hustlers” (property entrepreneurs) would also be looking at UK property assets. “They get paid to invest and are hugely liquid, with big war chests,” the banker said. “They’ve kept their powder dry and debt is the element they now need.” The banker cited Raymond Mould and Delancey among those with the potential to be acquisitive. He added Blackstone could be eyeing opportunities in the sector.
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