For most private owners, the sudden presence of a public REIT next door is very bad news. However, what makes the REITs intimidating—their size and structure—can also make them vulnerable, says David Hillman, the founder and CEO of Southern Management.
Indeed, Hillman and others say the presence of a REIT right next door isn't a kiss of death and that there are a host of other deals—more creative acquisitions with a greater upside—that REITs usually can’t consider because of constant, short-term pressure from Wall Street to produce quarterly earnings.
As a result, more nimble, entrepreneurial organizations can use their size to their advantage by responding more quickly to opportunities.
“A freighter can carry a lot more cargo,” says Matthew Lester, founder and CEO of Orchard Lake, Mich.-based Princeton Enterprises. “But a speed boat can turn on a dime.”
Here are six ways that smaller, private apartment firms can compete with the public REITs.
1. Take advantage of the REITs' down time.
When the recession hit, many public REITs froze, hunkering down in light of falling stock prices. Meanwhile, private firms such as Princeton Enterprises were extremely busy.
In 2008, Princeton acquired 20 apartment communities and over the last six years, its portfolio has tripled to 15,000 units. Last year, they purchased 660 units last year, and in the first four months of 2011, scored another 640 units—all of which were distressed.
“Funds from operation are what drives REITs day in day out, but we can shift on the fly,” says Lester. “I can cease to emphasize cash on cash distributions and shift toward renovation, which during the last downturn was crucial.”
2. Consider significant rehabs.
LumaCorp, which owns 4,600 units throughout several Texas markets, watched REITs drive up the price of Class A assets in Dallas/Fort Worth. So, the company is targeting value-add deals and is currently in a best and final stage on a property that will need $2 million in rehab over an 18-month cycle.
“That’s an area REITs can’t really play in, pumping the money in on a value-add play,” says Ian Mattingly, director of acquisitions and asset management at Dallas-based LumaCorp. “They’re in it for the cash flow.”
3. Leverage local knowledge.
Being knee-deep in operations breeds a level of local knowledge that’s irreplaceable. One supposed advantage that REITs have is “access to information,” a deep level of research that measures a submarket’s fundamentals and trends. But that research may not be worth the paper it’s printed on.
“The on-the-ground information a smaller private holder has is far more valuable, current and relevant,” says Matthew Lester, founder and CEO of Orchard Lake, Mich.-based Princeton Enterprises. “The information furnished to REITs lags what I already know in a particular marketplac
4. Understand the markets.
Laguna Niguel, Calif.-based Raintree Partners has tried to outmaneuver the REITs by finding offmarket deals for both assets and land. There are so many offmarket possibilities in any given market that REITs can’t be on top of every one, especially if they’re based in other parts of the country.
“We’ve spent a ton of time on making unsolicited offers directly to owners, and identifying brokers who want to work on offmarket deals, so that we’re the first phone call when they find one,” says Aaron Hancock, director of acquisitions for Raintree. “We know the markets and people very well, and there’s a potential to get an advantage in certain transactions because of that.”
5. Offer the ability to quickly close.
Princeton Enterprises has cultivated a stable of lenders, such as the GSEs, life insurance companies, conduits and banks to act quickly. “You have to go to your lender pool and say, I’m not interested in fighting over 10 bps on an interest rate,” says Matthew Lester, founder and CEO of Orchard Lake, Mich.-based Princeton Enterprises. “But I’m going to insist that you give me deal certainty, that you’re going to be there for me.”
The same goes for the company’s equity investors, some of which can take down a whole deal, debt and equity, if necessary. In the secondary markets and distressed acquisitions where Princeton plays, this assurance of close has been a big advantage.
6. Launch creative programs.
Smaller owners can also use their flexibility to implement programs most REITs would never dream of. For instance, the Village Green Cos has lowered its operating expenses each year since 2008 by bringing a variety of previously sub-contracted services—renovation, landscape architect, interior decorator, advertising, green building experts—in house. The company also now trains its maintenance staff in electrical, HVAC and plumbing work, raising their compensation in the process, so that very little is now farmed out.
“We’ve reinvented ourselves in how we hire, train and compensate people,” says Jonathan Holtzman, chairman and CEO of Farmington Hills, Mich.-based Village Green Cos. “This recession taught us how to dramatically reduce our operating expenses—we’re not relying on rent increases, we’re relying on NOI growth in part from lower expenses.”
