Contributing Reporter

A rising tide of merger-and-acquisition is shaking out the REIT industry.

Industry experts expect the trend to result in both a decline in the total number of REITs, as well as big growth on the part of the surviving companies.

Officials of local Los Angeles-area REITs say they expect to survive and grow by buying real estate not by merging with, or preying on, other companies.

The mergers-and-acquisition trend is strongest among the REITs that own property types over-represented in the REIT market, such as shopping centers, mobile home parks and apartment buildings.

In the past year, there have been three mergers among apartment REITs, and the current field of 30 apartment REITs nationally may drop to about 15, according to Kathryn Creswell, an analyst with Alex. Brown & Sons in Baltimore, Md.

The growth potential among the surviving companies was dramatized last year by several multi-billion dollar deals. To date, the biggest REIT merger combined the assets of two of the nation’s largest retail developers: Simon Property Group and DeBartolo Realty Corp., with a market capitalization of about $8 billion.

At least “one or two” more mergers can be expected in the crowded field of retail-based REITs, according to Thomas O’Hern, chief financial officer of Macerich Co., a Santa Monica-based shopping center REIT.

But it is purchases of real estate not acquisitions of other companies that will be the primary growth vehicle for REITs in the near future, according to Macerich’s O’Hern.

“There may be a few mergers, but frankly, we expect much more growth to come from the movement of private ownership into the public side, both in terms of new companies forming IPOs, as well as existing (public) companies acquiring assets,” O’Hern said.

Macerich is already among the bigger buyers. Since going public in 1994, the company has more than doubled its real estate holdings, said O’Hern. Currently, Macerich has a market capitalization of about $1.8 billion, making it one of the 25 largest REITs in the nation.

Beverly Hills-based Arden Realty Inc. is also on the buying trail, according to president and chief executive officer Richard Ziman. And while the Arden executive would not rule out buying out a rival REIT, he sounded skeptical.

“We are looking at portfolios and properties, rather than paying a premium by buying another REIT,” Ziman said.

The consolidation of the REITs, in part, reflects the desire to grow and provide value to shareholders. In view of the gradual growth generally offered by real estate, the REITs that want to grow quickly must do so by bulking up their portfolios.

Another reason is the “economies of scale,” according to Rich Kwas, a research associate at the National Association of Real Estate Investment Trusts in Washington, D.C. “Bigger, stronger companies are buying weaker companies with higher costs of operation. So what you are seeing is that most of the larger companies are strengthening themselves by acquiring smaller companies that own the kind of portfolios the buyers want to get into,” he said.

Wall Street offers rewards to companies that grow, according to Creswell.

“Institutional investors continue to raise the bar on the minimal size of the companies they will invest in; for some, it’s got to be at least $500 million for inclusion in a given mutual fund,” Creswell said.

NAREIT’s Kwas predicts that the merger-and-acquisition trend in the REIT market will continue for “two or three years,” with the emergence of the new class of Super REITs, and a decline in smaller companies.

“The bigger ones are bigger and bigger and the smaller ones will either cease to exist or fall out of favor (with investors) and more than likely they will not be able to compete with the big REITs, so they will have to sell out,” he said.

But REITs can grow without merging with other REITs, in part because they are in a good position to buy real estate, according to Macerich’s O’Hern.

Public companies have a lower cost of funds than do most private investors, he pointed out.

Lenders often demand that private investors contribute 30 to 40 percent equity from borrowers, which is “extremely expensive” for the private companies, O’Hern said.

“With a much higher cost of capital,” he added, “it’s difficult for the private companies to compete with public companies in terms of acquisitions.”

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