Why Are REIT M&As So Rare?

By Britton Costa, Associate Director, REITs, Fitch Ratings: Mergers between publicly traded REITs have historically been sporadic. Thus, when one does occur, it typically stokes the long-simmering REIT M&A debate.

Britton CostaMergers between publicly traded REITs have historically been sporadic. Thus when one does occur, it typically stokes the long-simmering REIT M&A debate. That is, will the most recent merger be the catalyst for the industry’s consolidation and maturation (a role that M&A has served in most other industries)?

Fitch Ratings believes public REIT M&A transactions will continue to be a rarity for a few notable reasons. Namely, symmetric information for valuing REITs and the lack of meaningful synergies reduce the total return potential, such that structural and social obstacles are sufficient to ward off unsolicited advances.

For one, M&A is an important mechanism for price discovery in most other industries. Target companies’ securities prices may deviate from their intrinsic value as all material information may not be publicly disclosed, known or readily understood. In contrast, REITs are relatively simple to value and the inputs are readily available — resulting in symmetry of information between buyers and sellers; thus fewer opportunities for large arbitrages, correspondingly, the dearth of M&A deals.

A sometimes equally as important return component for M&A is synergistic savings; specifically, improving margins through economies of scale (e.g. increased purchasing power or more efficient manufacturing, distribution, marketing, or research and development). Few, if any, of these factors that comprise the majority of typical corporate expenses apply to REITs. Other than capital itself, REITs have no costs of goods sold. Operating expenses, such as utilities and taxes, tend to be property specific and are often passed through to the tenants while leasing costs are capitalized.

As if lower potential returns were not enough to discourage M&A, structural considerations make hostile deals difficult and even friendly deals complex and time-consuming. REITs’ organizational documents typically limit any one shareholder’s ownership to 9.9 percent or less for tax purposes. Thus, a potential acquirer would need the target board’s support or risk having an insufficient number of shares to control the outcome of matters put to a vote. As such, social issues, which are the least defensible and easiest to surmount in theory – but not always in practice, become the gatekeeper for M&A.

Looking forward, Fitch Ratings expects REIT M&A activity will continue to be achievable but sporadic and the industry’s consolidation and maturation will differ from most other corporate sectors.