REITs Are Poised to Pick Up the Pieces

By ANTON TROIANOVSKI Overleveraged private real-estate funds are gasping for money, but public property companies have been chugging down cash from the capital markets. Now, they are poised to emerge as more-dominant players when the commercial-property-market starts to recover. Many expect the landscape change to be as profound as it was in the early 1990s, when many real-estate developers went public to avoid bankruptcy and helped turn real-estate investment trusts into a major force in the property market. Most of the leading private real-estate funds during that time vanished from the scene. REITs are poised once again to pick up the pieces from the commercial-property bust. This year, they have tapped the stock market for nearly $15 billion in new equity and, this month have raised $2 billion in unsecured debt. The equity deals diluted shareholders' ownership stakes, but positioned many REITs -- such as mall owner Simon Property Group Inc. and warehouse landlord ProLogis -- to avoid loan defaults and have buying power when distress hits the market. Few of the private-equity funds that became Wall Street stars during the boom can say the same thing. An increasing number are trying to raise cash to recapitalize existing investments. But the strategy has been a hard sell. The Townsend Group's Martin Rosenberg, who consults institutions on their real-estate investments, says he has seen 16 funds make such proposals since late last year, but only one has raised all the equity it asked for. Two others raised part of what they were seeking, and two more are on track to succeed, Mr. Rosenberg adds. Funds also are having trouble raising money to take advantage of distressed opportunities because their traditional investors -- pension funds and other institutions -- have little to invest after going on a real-estate binge in the mid-2000s. The country's 50 biggest public pension plans are on pace to commit only $5 billion to real-estate investment vehicles this year, according to trade publication Real Estate Alert. That would be the lowest total since 2003, compared with $17 billion last year and a peak of $36 billion in 2007. In all, property funds raised $370 billion from 2003 to 2008, according to Probitas Partners, a San Francisco research firm. They were seen by many investors as being more nimble than public REITs, and they goosed returns with mountains of cheap debt. All that debt has led to a spate of bankruptcies at companies taken over by private-equity funds -- such as Morgan Stanley Real Estate's Crescent Resources LLC and Colony Capital LLC's Station Casinos Inc. -- and huge markdowns across the industry. Even Prudential Financial Inc.'s $11 billion PRISA fund, with a reputation as one of the most conservative in the industry, told investors last month to expect a 55% peak-to-trough loss by the beginning of next year. Private-equity funds invest money from pension funds and other institutional investors to buy properties or entire real-estate companies. They collect part of the profits and earn management fees. Shares of publicly traded REITs, meanwhile, can be bought and sold by rank-and-file investors. REITs, under closer scrutiny from analysts and shareholders, didn't take on as much debt as their private counterparts and proved to be astute sellers as the market peaked. In 2006 and 2007, as values skyrocketed and private-equity funds and institutional investors were net buyers of $134 billion of property, public REITs sold $94 billion more in real estate than they bought, according to Real Capital Analytics data cited by Green Street Advisors. Several publicly owned landlords, including Equity Office Properties and apartment giant Archstone-Smith Trust, went private in huge buyouts. Their more-conservative strategy is now paying off, and REITs' lower leverage and greater transparency is attracting investors rattled by the downturn. Investors rushed into the sector this spring after REITs fell 75% below their February 2007 peak. A survival-of-the-fittest storyline that many expected turned into a much broader rally as at least 48 successful stock offerings injected cash into the REITs. "Everyone was predicting a have-and-have-not scenario, and that didn't play out at all," says Debra Cafaro, chief executive of health-care REIT Ventas Inc. "What happened was indiscriminate access to capital, which has buoyed the whole sector." REITs, to be sure, are still suffering, and no one can tell when the commercial real-estate market will start to recover. The Dow Jones Equity All REIT Index is still at about half its February 2007 peak. The dilutive effect of the REITs' equity offerings has dismayed many investors, and some are wary of how volatile REIT stock prices have become. Some private-equity funds, meanwhile, still have "dry powder" -- cash commitments from investors that haven't yet been put to use. But most agree that public companies now have the best access to capital, the lifeblood of real-estate investing. Starwood Capital Group LLC, which operates several private-equity property funds, recently raised $810 million in the public market to buy distressed debt, and other firms have said they will try the same thing. "I think there are times when the public market is the better solution for a greater variety of strategies and a greater variety of assets, and I think that's more true right now than it's been in a while," says Randy Rowe, the chairman of Green Courte Partners LLC, a Chicago private-equity real-estate firm. Write to Anton Troianovski at anton.troianovski@wsj.com