REIT Industry Contends with Implications of Discounts to NAV

Experts Keeping an Eye on Balance Sheet Liquidity

Pictured, left to right: Owen D. Thomas, CEO of Boston Properties; Martin Stein, CEO of Regency Centers; Glenn J. Rufrano, CEO of VEREIT; Anthony Malkin, CEO of Empire State Realty Trust; Ric Clark, chairman of Brookfield Property Partners; Jeffrey Horowitz, global head of real estate, gaming and lodging investment banking at Bank of America Merrill Lynch (moderator).
Courtesy of NYU Photo Bureau / ©Olivo

At the 23rd Annual NYU REIT Symposium on March 20, the REIT industry’s movers and shakers spoke candidly about the various forms of disruption encountered over the past year in their sectors, but in almost all instances the talks brought a caveat – implementing innovative tech requires a strong balance sheet.

In the most disruptive of periods, the best hedge is a strong balance sheet, panelists said. And although the topic du jour at the Pierre Hotel conference center was disruption, another d-term would continually resurface: discount to NAV.

Panelists delved foremost into Proptech, a buzzword encompassing technology solutions for the real estate industry. Venture capital (VC) investment into real estate technology totaled $12.7 billion in 2017, up from $4.2 billion in 2016 and $1.8 billion in 2015, according to a recent report by RE:Tech.

"There is a healthy amount of capital that has been invested in Proptech. We will certainly want to adopt any technology that will allow us to either, one, serve our customers better, or two, save money," says Owen D. Thomas, CEO of Boston Properties. "[But] real estate is a difficult business to propagate different technology through. Every building is different, with different tenant bases and features. It is challenging to replicate one technology uniformly."

The biggest benefactors of VC fundraising in 2017 were WeWork and Compass, with $4.4 billion and $550 million raised respectively, RE:Tech found.

Some panelists allowed that they saw co-working as a phenomenon showing how workspaces are adopting new technologies, but others were not so forgiving. Because of high turnover from the various levels of membership plans, it’s very hard to have a secure facility with WeWork, said Empire State Realty Trust CEO Anthony E. Malkin.

WeWork has signed 4.77 million square feet in New York City leases since January 1, 2010, according to CoStar data, making it the largest tenant company this cycle. About 2 million square feet of this activity has occurred since January 1, 2016.

Citing WeWork’s brokerage agreements with Cushman & Wakefield and CBRE, panelists said the company is positioned to disintermediate landlords and tenants. In 2017, it announced Powered by We, effectively a property management suite of technologies.

Technology for Efficiency

Real estate is still in the first inning of transformation, noted Kimco Realty CEO Conor Flynn, adding that his firm will be investing in technology to unlock the potential embedded in its portfolio.

"There is probably more supply than demand in the Proptech business," said Malkin. "We look at technology in three ways – where is the risk in disruption, what services do we need to be more efficient, what do we need to provide for tenants to do their business."

His company is focusing on energy management systems, which calculate the occupancy of the building, weather characteristics, and the settings the building should run that day for optimal performance.

"We’ve invested a lot in the back of the house," said Ric Clark, chairman of Brookfield Property Partners, noting energy management systems that help to control cost. BLANK is also reinvesting in its buildings via capital improvements.

"I’m not sure that tenants really notice [back-of-house investments]. With the rise of millennials, tenants are noticing available amenities as they attract top talent. It is hard to say if we are making money or not [with amenity improvements] but it is just part of doing business. It’s kind of a nuclear arms race in New York City - 40 buildings in midtown, 40 in downtown having massive capital investments to keep up," he adds.

Panelists also cited tenant service apps, particularly for office occupiers, with an app that functions as a building pass and can contact food and transportation services.

Cash is King

Soon enough, talk turned to balance sheets. According to moderator Thomas Grier, global head of real estate at J.P. Morgan Securities, about 75% of REITs are trading below NAV.

"NAV is a hotly debated topic with no obvious right or wrong answer. Private markets which are not subject to price and market gyrations - they don’t want to have to deal with that," said Wendy Silverstein, CEO of New York REIT. "In a private company, the values are more accurately reflected. There are headwinds in public market that play into the NAV."

Silverstein is tasked with undertaking a shareholder-approved liquidation of New York REIT’s asset portfolio.

"We’ve sold most of the assets in one year. HNA bought 245 Park Avenue at a relatively blockbuster price. We think we know how that is going to end. That was a slow market. Maybe prices are better this year because there’s been pressure to invest this dry powder, but when you are liquidating you have to think about delivering value to shareholders."

HNA is reportedly planning to sell 245 Park Avenue, which it acquired for roughly $2.2 billion last year. New York REIT’s stake in One World Wide Plaza is reportedly being marketed for sale by Eastdil Secured.

"A tighter balance sheet is more important now with all the debt capital available. It’s also a harbinger of things we’ve seen before. A strong balance sheet is insulation, it is defense and offense," Malkin added.

A strong balance sheet should also help REITs ward off activist investors, noted Sherry Rexroad, managing director at BlackRock.

"Any time you have weak corporate governance, you are opening yourself up to activists entering the stock because that is the easiest way for them to do it," she said.

Yet analysts speaking at the event rang somewhat of a warning bell.

"Real estate is not a financial asset, it is a real asset. We’ve seen deceleration in fundamentals. We do think REITs look cheap versus private real estate. The gap of perceived discount to NAV is telling us that we will see little real price growth," noted Jon Cheigh, executive vice president at Cohen & Steers.

"We are late-cycle. We should be below the 5-10% discount to NAV late-cycle," explained Theodore Bigman, managing director at Morgan Stanley Investment Management. "The issue is we are way below that range. We haven’t had average discounts at this level since the tech bubble. We think the disconnect is too big," he added.

Equity Commonwealth CEO David Helfand said NAV had different implications for his company.

"NAV limits our currency to grow. Cash balance is the best for us. Ultimately it is a cost of capital decision – can you make acquisitions that accrete that spread of cost of capital and what you are buying? With our real estate trading at a discount, cash is the vehicle of growth," he added.

Green Street Advisors’ Mike Kirby identified a trend tied to REITs trading below NAV.

"Looking forward, the public market is saying something bad is going to happen to private real estate pricing. I don’t buy into it, but it is a signal. When REITs trade at discount to NAV, prices tend to go down in the next 12-18 months," Kirby explained. "There are dire times ahead for gateway office and apartment markets, particularly in New York. Those are trading in the public space at the biggest discount. It means private values are probably going down in those places."

Pictured, left to right: Conor C. Flynn, CEO of Kimco Realty Corporation; Jeffrey S. Olson, CEO of Urban Edge Properties; Michael J. DeMarco, CEO of Mack-Cali Realty Corporation; David Helfand, CEO of Equity Commonwealth; Thomas Grier, global head of real estate, gaming and lodging investment banking at J.P. Morgan Securities (moderator).
Courtesy of NYU Photo Bureau / ©Olivo