What was inevitable to investors and analysts finally happened on Dec. 19, when the REIT Essex Property Trust signed a definitive agreement to acquire BRE Properties in a cash-and-stock deal estimated at $4.34 billion. This combination, if approved by the companies’ respective shareholders, would create the largest publicly traded apartment REIT on the West Coast.
The two multifamily operators, both based in Northern California, had been circling each other, on and off, for more than a year. Their “marriage,” as one analyst called this transaction, includes nearly 56,000 housing units within 239 communities primarily in Seattle and California; $1.2 billion in annual revenue; and $10.4 billion in equity market capitalization. There’s 90 percent overlap in their geographies, and half of BRE’s properties are within two miles of Essex’s apartments.
“This merger is a great sign for the market, that two firms of their statures have the confidence to go through with a deal this size,” says Dan Fasulo, managing director of investment advisory firm Real Capital Analytics (RCA). Michael Schall, Essex’s CEO, who will run the combined business, called the agreement “a once-in-a-career opportunity” during a conference with analysts on the day the companies officially announced their deal.
Sorting Out the Details
The agreement came together in a little more than a month, so there are loose ends that still need tying up, such as the composition of the new company’s management team; the institutional structure under which Essex will shift assets into joint-venture partnerships; and decisions regarding which assets will be retained or sold.
Essex and BRE, through their respective spokespeople, declined to comment beyond their public statements about this deal, and said that more information would be forthcoming in a proxy statement that the companies are required to file with the SEC within 45 days of their agreement.
Interviews with analysts and investors paint a picture of an investor-driven deal that merges two large multifamily operators with similar strategies but different strengths. One small investor in particular latched onto BRE’s leg like a terrier and refused to let go until that company did something to improve shareholder value that has lagged its peers’ performances.
A chronology of the Essex–BRE deal should begin not with either company, but with the $16 billion acquisition of Archstone Enterprises by AvalonBay Communities and Equity Residential in late November 2012. The magnitude of that transaction—which included cash, stock, and assumption of debt—“validated our evaluation of BRE,” asserts Jonathan Litt, CEO and founder of Land and Buildings, a Greenwich, Conn.–based investor that in October 2012 bought 200,000 shares of BRE’s stock.
At the time, recalls Litt, his firm “found it incredibly intriguing” that while BRE owned some of the best assets in the best markets, its stock was available at 30 percent below the $68 per share price Land and Buildings had calculated was BRE’s true market value. “Now is the time … to put BRE Properties up for sale to the highest bidder,” Litt wrote to investors in December 2012.
A possible bidder had emerged a month earlier, when Essex disclosed buying a “strategic” stake in a competitor that was widely believed to be BRE. BRE, in turn, rewrote its bylaws to make it harder for investors to unseat BRE’s existing board.
Essex eventually sold that stake. And as it entered 2013, BRE’s management, according to CEO Constance Moore, began what became a nearly yearlong evaluation of “strategic alternatives.” But management didn’t disclose specifically what alternatives it was considering, and in June Land and Buildings offered to purchase BRE on behalf of an investor consortium for $60 per share. BRE rebuffed that offer, but it continued to have what Litt characterizes as “mostly friendly” conversations with Land and Buildings through September.
BRE’s rejection of Land and Buildings’ offer “raised more noise from investors about BRE’s performance,” says Ryan Bennett, a multifamily REIT analyst with Zelman and Associates.
A Logical Fit
Indeed, BRE may have been facing increasing pressure from investors, culminating in a dinner during the National Association of Real Estate Editors’ Fall Summit in early November. According to analysts whom MFE interviewed for this article, that dinner brought together key investors with a number of BRE board members, including its independent chairman, Irving Lyons.
“I spoke with executives from both companies [about that meeting], and BRE got a clear message about what needed to be done,” says Rich Anderson, an analyst with BMO Capital Markets. Alexander Goldfarb, senior REIT analyst with Sandler O’Neill, believes that dinner ultimately “forced” BRE’s board “to investigate what its alternatives were.”
By all accounts, BRE and Essex weren’t on each other’s radar yet when Essex held its “Investor Day” event on Nov.12. In Anderson’s recollection, Essex was “noncommittal” about acquiring BRE but “left the door open” for future negotiations. It didn’t take long for the rumor mill to start churning, especially after Bloomberg published a story on Dec. 4 reporting that Essex had offered to buy BRE for around $5 billion.
Five days later, Essex confirmed that it had made a nonbinding offer, which eventually led to the definitive agreement between the two companies.
BRE shareholders will convert each of their shares to 0.2971 newly issued Essex shares and receive $12.33 per share in cash. The transaction is valued at roughly $56.21 per share, or around $4.3 billion. Essex has $1 billion in financing available to fund the cash portion of this deal.
Analysts can only speculate about why the parties reached an agreement when they did, and at that price. RCA's Fasulo thinks a multifamily market “moving in the right direction” made this deal more palatable to both parties. He also notes that the debt market “had become healthier and more robust. Eighteen months ago, no one was talking about big portfolio transactions.”
Litt of Land and Buildings notes that BRE shareholders are getting “undervalued” Essex stock, which should appreciate. “We would have been more upset about [the selling price] if this had been an all-cash deal.”
Litt points out that nearly all of BRE’s properties are in West Coast markets that are in various stages of recovery, meaning that their long-term prospects look strong. Zelman's Bennett thinks the deal “reweights” the new company’s portfolio toward Southern California. Schall had stated previously that Essex anticipated that Southern California's growth rate would accelerate and, in the next few years, reach an equilibrium point with Seattle and the Bay Area.
Anderson of BMO says this deal “eliminates a competitor for Essex” and gives that company “control of [BRE’s] neighboring assets,” which could lead to “operational and management synergies” from the proximity of communities.
Spearheading the integration of the companies is John Burkart, Essex’s executive vice president of asset management. Schall expects Essex to gain efficiencies from BRE’s marketing and procurement expertise. But the general consensus among industry watchers is that BRE’s subpar performance by such measures as stock price and funds from operations (FFO) attests to managerial weaknesses that Essex’s “superior management,” according to Anderson, would shore up. “What separate the successful from the mediocre are operating and investing, and BRE never really developed those skill sets,” says Sandler O’Neill's Goldfarb.
(BRE’s net income–to–revenue ratio was actually stronger than Essex’s through the first nine months of 2013. But the day they announced their agreement, Essex’s stock price closed at $144.66 per share, versus BRE’s $54.87 closing price.)
Tip of the Iceberg?
The Essex–BRE agreement is the third major “crossover” deal in the multifamily sector within the past 15 months, the others being the AvalonBay–Equity acquisition of Archstone, and Mid-America Apartment Communities’ $2.2 billion acquisition of Colonial Properties Trust last May.
Short of “a massive spike in interest rates,” Fasulo thinks these deals might augur further consolidation in the multifamily sector. Two other apartment operators—Home Properties and Post Properties—are regularly mentioned by analysts as possible acquisition targets.
But analysts generally don’t see the Essex–BRE deal as a competitive game changer, nor one that will spur more mega deals or alter the “math” in negotiations. “Hostile takeovers in REIT-land are very rare; there needs to be a willing bride,” observes Goldfarb. And Anderson of BMO thinks the next phase of industry consolidation “will require more vision. I would be cautious about investing in this market because you anticipate consolidation.”
John Caulfield is a contributing editor to MFE.