The last few weeks have seen some significant REIT mergers/takeovers in the UK – LXi with London Metric; Tritax with UK Commercial Property REIT; Custodian Property Income REIT with Abrdn Property Income Trust; and Barratt Developments agreeing a £2.5 billion deal to acquire fellow housebuilder Redrow. What is behind the sudden uptick in M&A activity?

Mergers between listed property companies are not a new occurrence. In the US, between May 2022 and August 2023, there were 15 new REIT M&A transactions, of which 12 were public-to-public transactions. The background to that period saw rising interest rates, a return to some sort of normalisation after the pandemic, shareholder activism and global economic uncertainty. Similar issues remain and new ones, such as lack of deals and falling valuations, are present.

Each deal of this type is different but, when searching for underlying trends, it is possible to see how a REIT can view taking over another public company as an effective way of upsizing and improving its portfolio at a time when debt is expensive and difficult to source. This is particularly interesting given the continuing uncertainty surrounding open ended real estate funds following the suspensions and closures of high-profile funds announced in Q4 2023.

The current market may be more conducive for public-to-public deals, as REITs can use shares as their currency, whereas private equity buyers that rely on cash and debt have a higher cost of capital. 

Is bigger really better?

Growth prospects, scale, synergies and cost savings are often given as the reasons for takeover activity.

Takeovers can result in an increase in scale for both participants, whether it is a mega company with a strong balance sheet taking over a small player, or a modest market participant seeking a tie-up with a larger partner, possibly to access a lower cost of capital and rid itself of the fiscal drag of the ongoing costs of public company compliance and regulatory requirements. 

With an increase in scale come cost savings and operating efficiencies, not to mention the benefits of a stronger combined balance sheet and the potential for access to a wider source of capital, as well as enhanced liquidity of stock, which has the potential to allow for a wider range of institutional shareholders from all over the world to become investors.

In the real estate market, much is made of the pricing mismatch between what sellers want to receive and what buyers are willing to pay. In the listed company arena, a similar problem exists, at least currently, as the interest rate environment has resulted in most listed REITs trading at a discount, sometimes a significant one, to their net asset value. Finding a suitable and acceptable offer price is a major hurdle to many mergers, but the mutual benefits on offer can make this issue easier to overcome than on individual asset deals. 

The mismatch between NAV and the value the market puts on REITs has left a number exposed to potential takeovers. For some, the logical defensive move may be themselves to expand and scale up, either by acquisition of a competitor or a merger.

More consolidation on the way?

Overall, the trend sees large REITs and possibly new entrants looking at M&A as a way to grow their portfolio, as opposed to taking on more debt to develop or acquire properties. For the smaller companies, in a challenging market where it is difficult to raise new money, delivering returns is a challenge and the cost of capital is high – being taken out by a larger suitor willing and able to pay a premium will likely remain an attractive proposition.