Expect More REIT Consolidation With GICS Change, Observers Say

Industry observers expect the upcoming change to the Global Industry Classification Standard to augment the REIT industry's prominence in the investment arena and accelerate consolidation in the space.

On an SNL Knowledge Center-sponsored webinar June 1, a trio of players said the influx of capital that is expected to attend real estate's breakout from financials will benefit all public REITs, but principally the big players that have established scale and operational prowess.

"While they may not see the immediate benefit," Equity Residential President and CEO David Neithercut said of smaller REITs, "I think it's something that's good for real estate, and something that is good for real estate is good for all players in the space."

Neithercut, who as NAREIT chair in 2015 helped lobby for a separate silo for real estate, framed the change as "just one more step of many steps" in the growth and maturation of the REIT industry overall over the last several years. He expects there to be bigger REITs in 10 years, but not necessarily more in number.

The bar has absolutely gotten higher and higher, in our estimation, and will remain so
Jim Kammert, principal and portfolio manager with Harrison Street Securities, said the classification change will continue to drive a "virtuous cycle" among the marquee REIT names. Their size and reputation will attract much of the new capital, which in turn will augment their size and reputation further. He posited a scenario where, in four or five years, 70% or more of the industry's market capitalization will be captured by 30 to 40 companies.

"I think these bigger companies with much more retained capital in proportion to EBITDA, much larger self-funding capability if you will, will accrete to higher and higher multiples," Kammert said.

BB&T Capital Markets analyst David Toti forecast an increase in growth and activity across the REIT spectrum. The "megacaps" will flourish, but there will be new entrants as well, even as the hurdles to IPOs remain relatively high.

"There's a lot of different cross winds. Net-net I think it all speaks to increased capital in the space and growth in the companies," Toti said. "I think we're going to continue to have a lot of megacaps, and we're going to continue to have new entrants as well, at the other end of the spectrum. So as a generalist, many investment options are going to remain for some time."

Kammert, for his part, was conservative on the prospect of increased IPO activity and said the already high bar for successful new capital raises likely will be pushed even higher. Unless the prospective entrant's story is something unique, it will be difficult to compete with the cost of capital advantages the kingpins in the space have.

"The bar has absolutely gotten higher and higher, in our estimation, and will remain so," he said.

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On the positive side, the influx of new capital will likely have the side effect of mitigating the public-private pricing divide and lowering REIT market volatility in general, Equity Residential's Neithercut said. More investors and more dollars in the space will keep demand steady, making pricing disconnect episodes comparable to the one in 2007 less likely.

"I just don't think we'll see situations where that disconnect will ever occur again as there's more and more participants in the space, and as the space gets larger," he said.