Market Commentary | August 29, 2023
Paths to Growth
Higher interest rates have made commercial real estate prohibitively expensive. Higher interest rates have destabilized the regional banking system through the evaporation of no-cost deposits, which resulted in a raft of stricter banking regulations that further restrict commercial real estate lending. The resulting tighter credit has nearly ground real estate transactions to a halt and pressured REIT share prices in the absence of visible paths to acquisitive growth.
Or at least that was the situation until just before markets opened on August 28th. It’s called Merger Monday for a reason, and yesterday was a doozy for the real estate sector.
Combine and Conquer
Kimco Realty (KIM), a $12B grocery-anchored shopping center REIT earlier reported strong 2nd quarter leasing activity and rising rental income, but its shares are down 10% in 2023, trading below the sector average at just 12x FFO. RPT Realty (RPT), a $750MM grocery-anchored shopping center REIT reported 2Q results that were even stronger than KIM’s, but its shares were still down 2% in 2023, trading below 10x FFO.
On Monday, KIM announced it would acquire RPT in an all-stock transaction. In the press release, Kimco claimed the acquisition would be immediately accretive to FFO, was leverage neutral, and provided multiple growth and value creation opportunities. RPT’s shares jumped 20% on the announcement. KIM gets its growth, RPT gets value; banks and higher interest rates didn’t even enter the picture.
A dozen other retail REITs trade at disparate earnings multiples and discounts to Net Asset Values. To grow, they can acquire new real estate in the open markets, or they can synergistically combine with their peers. We are likely to see more M&A in this sector.
Hersha Hospitality (HT) owns a couple dozen boutique hotels in Boston, New York, DC, Philadelphia, Northern California, and South Florida. We have toured and stayed at many of these luxury properties. Like the entire lodging industry, Hersha was brutalized by COVID-19 but came out the other side operationally stronger. Hersha’s problem though, is that it has too much debt, and refinancing that debt will be much more expensive.
On Monday, HT announced it would be acquired by KSL Capital Partners in an all-cash transaction. Hersha common shares will be exchanged for $10.00 (a 60% premium over the prior close) and its preferred series shares will be redeemed at their $25.00 par (a 25% premium of the prior close). KSL gets Hersha’s real estate which it feels is much more valuable than the cost.
Fifteen other hotel REITs have survived the pandemic, but their shares trade at huge discounts to intrinsic value. We anticipate numerous avenues will be explored to unlock that value.
The business world is ever changing. Opportunity is always present.
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