Raising Equity Capital in a Challenging Market

This post was written for The Ground Floor by Steven Ott, Crosland Professor of Real Estate at the University of North Carolina in Charlotte, North Carolina.

How can developers and commercial property owners/operators map viable strategies for raising equity for their firm and their firm's projects in today’s real estate market? A recent ULI workshop—"Equity Capital for Commercial Real Estate: Understanding and Navigating the Public and Private Options" held May 11th and 12th in Charlotte, North Carolina—addressed numerous issues and options, including the following:

• The Primary Private Options for Recapitalization in Today's Market: Private REITs; Fund Sponsorships; Programmatic Joint Ventures; Mergers with Investors; Corporate/Portfolio Recapitalizations.
• Finding the Right Fit: What Private Options Best Match Different Owner/Operator Types?
• Becoming a REIT: Costs, Benefits, Challenges, Pitfalls, Opportunities and Constraints.

One of the key concepts that was emphasized in the workshop was the option of converting to a REIT structure. The following highlights some of the major takeaways provided by the speakers who addressed the public equity market:

• REIT capital issuance continues to be healthy into 2010, with over $15 billion raised so far this year. REITs have raised over $65 billion in capital since 2009 to repair balance sheets and acquire funds for opportunistic investments. While many capital raises have been dilutive to existing shareholders, substantial positive REIT returns over the past few months have overcome this effect.
• REIT cost of capital at present is less expensive than private capital and this is reflected in the run-up of REIT shares over the last few months. REIT implied cap rates are now under 7 percent at 6.90 percent.
• The current low cost of capital for REITs has contributed to an IPO wave. The IPO wave is also being driven by the need to provide currency for acquisitions, avoid recourse obligations, and gain better access to bank lending.
• For those firms considering going public, public REIT investors are looking for the following company attributes:
• • Existing portfolios of stabilized assets;
  • Quality markets;
  • Geographic expertise/presence;
  • Limited asset types;
  • Niche strategies;
  • Attractive track records;
  • Solid corporate governance;
  • Quality CEOs and CFOs; and
  • Viable growth strategies.

• The public market prefers companies that have at least $500 million dollars of assets and up, although growth and niche strategies can be attractive at smaller levels of assets. Firms can be combined to create the critical mass necessary to go public.
• For companies that decide to give up their independence as a private company and turn themselves over to shareholders, permanent public capital gives strategic alternatives unavailable to private companies. However, taking a private company public is time consuming and expensive.
• Historically, REITs perform like stocks over the short term, but perform like real estate over the long term.

Speakers also addressed issues and opportunities for raising new capital in the private equity market:

• For most private developer owners/operators of commercial real estate, their first foray into raising private institutional equity capital is likely to be through a programmatic joint venture.
• Most deals that attract institutional capital require at least $50 million of equity or more, but some equity providers are willing to take on smaller deals in the $10 million range and up.
• For deals of less than $10 million, internal funds, country club money, and debt will remain as the primary sources of capital.
• Institutional equity capital is looking for company attributes similar to public investor:
• • Existing portfolios of stabilized assets, but they will consider value add and opportunistic plays;
  • Quality markets;
  • Geographic expertise/presence;
  • Limited asset types;
  • Niche strategies;
  • Attractive track records
• The cost to raise private equity generally ranges from 2-9% of the capital raised, with 2-4% as the common range. There are economies of scale, so smaller deals cost more. Fees on deals that meet the characteristics listed in the previous bullet point will be less than those that don’t.
• Generally, institutional private equity wants the sponsor to have at least 5-10%, and often times more, of their capital at risk in each deal. However, the amount depends on the financial strength of the sponsor, with more required from those with better balance sheets.
• Few commingled funds are being successfully completed at present and these often require $300 million plus to have any chance at success.
• Private equity is becoming more interested in entity level investments as a way to gain access to a company’s assets and growth opportunities.
• New development is currently shunned by the market, with no near-term end in sight. Assets are selling at below replacement cost, making development a losing proposition.

While times are tough for the real estate market and for raising equity capital, firms with solid track records and a good story to tell are finding ready and willing capital, especially as the economy recovers and the capital markets continue to mend.