Commercial Real Estate Finance

As I’m sure most of you heard, yesterday Simon Property Group made an unsolicited offer to acquire General Growth Properties for about $10 billion, which translates to $6 per share in cash and $3 per share interest in Simon’s assets.  For those who didn’t realize, the largest mall owner in America just bid for the assets of the second largest mall owner in America.  While traditional fears of the issues a corporate monopoly could pose in terms of thwarting fair market competition do not really apply in real estate, there is an interesting parallel.  If a corporate company has a dominant market share in a given industry, it can lower the prices of its goods or services to undermine its competitors.  While it may lose money in the short term by setting prices below the supply/demand equilibrium, it will gain in the long term by driving its competitors out of business.  While  mall owners do not really offer any good or service to the public, the same effect could occur if Simon is successful.  After all, we’ve seen signs of it happening int he commercial real estate marketplace already…

Suppose you are a regional mall owner/operator who pales in comparison to the size of either Simon or GGP (let alone the gigantic size both put together would produce).  If you had an opportunity to bid on a regional mall that was on the market, your success would generally depend on the level of information every bidder had.  As the old CRE adage goes, the bidder with the most information usually wins.  This is because such a bidder might see value where most bidders do not.  Take the failed Stuyvesant Town - Peter Cooper Village purchase by  Tishman Speyer and company.  At the time, other bidders thought Tishman’s purchase price was insanely high.  However right they ended up being, clearly, Tishman felt it could raise rent controlled apartments to market as a way to achieve lofty returns, thus making the perceived high purchase price a worthwhile one. Ironically, it turns out they had too little information, given that they illegally did so in many instances and are now being sued on top of losing the asset.

However, is information really what is controlling bid prices for assets?  We have heard numerous stories of clients who have bid on assets after having done extensive due diligence, feeling they might have been reaching for the property, only to learn that they were outbid by some much larger private equity firm or REIT by a landslide.  In such instances, did the big bad  firm actually have significant information about the asset to uncover some unseen future value, or did it simply have more money to throw at the seller?

Clearly, well capitalized bidders have an advantage over the little guy in the sense that they can pay all cash and worry about the financing at a later date.  Not having to worry about financing is a huge plus to a seller.  But usually, that luxury results in a lower purchase price, as the seller will offer a discount to an all cash buyer for greater assurance that the transaction will close, and close more quickly.

But that doesn’t seem to be what is going on currently in the marketplace.  While it is never in the best interest of any company, big or small, public or private, to pay more for an asset than they have to, perhaps there is something else going on.  Could REITs and their ilk simply be slightly overpaying as a way to ensure continued growth?  Since REITs are mandated to dividend 90% of their cash flows to shareholders, you have to keep growing NOI, or else risk your ability to raise more capital in the public markets because of a lower dividend.  In this sense, REITs might be acting like a corporate firm with a monopoly.  They can afford to lose out in the short term by overpaying for an asset, but in the long term, they grow their NOI, continue chugging along like the juggernaut they are, and end up controlling all the trophy assets at the end of the day, leaving the private investors to fight for the lower quality assets they feel aren’t worth owning in the first place.

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