As economic uncertainty drags on, a group of REITs are signaling trouble in hopes of pushing through an increasingly thorny patch of economic malaise.
A group of REITs this month announced efforts to “explore strategic alternatives,” industry jargon that means executives are looking to boost financial performance, whether through management shake-ups, mergers and acquisitions, restructuring or an outright sale.
The announcements kick off a process that can lead to revelations about an individual stock, a company’s assets or even broader market sentiment. The range of outcomes is wide, and there is no guarantee that outside investors are interested in helping fund a firm’s fresh approach.
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The gap between public and private valuations is often impacted by perceptions of the market.
“The easy part is to announce a strategic alternative. You hire the lawyers, you hire the bankers, you run a process, do the whole thing,” Piper Sandler analyst Alexander Goldfarb said. “The hard part is when you come back and realize that you called everyone around for a date to the prom, and no one returned your call.”
The pronouncements are part distress call and part marketing pitch, and they come as publicly traded real estate owners look to capitalize on pervasive uncertainty across markets by pitching themselves as underpriced hedges against near-term macroeconomic choppiness.
REIT stocks have ridden the same economic highs and lows as the broader equities market in the last year. The FTSE Nareit All Equity REITs Index was up 12 basis points for the year Wednesday morning, compared to the 88-basis-point rise in the S&P 500 since January.
Investor interest in REITs has flagged in recent weeks, and the 2.7% first-quarter growth in net operating income lags Q4 and annual numbers for 2024.
Paramount Group was one of three REITs in as many weeks to disclose that it was exploring strategic alternatives.
Executives at the REIT, which owns office towers in New York and San Francisco, decided to explore strategic alternatives to focus on “closing the persistent gap between the Company’s public market valuation and our assessment of intrinsic value,” CEO Albert Behler said in a statement earlier this month.
The REIT simultaneously announced the exit of two senior executives, one who held the roles of chief operating officer, chief financial officer and treasurer, and the other who was senior vice president, general counsel and secretary. The shake-up followed the March disclosure that Paramount made millions of dollars in payments to companies owned or partially controlled by Behler.
Paramount Group reported a $10M loss for the first quarter, less than a month before its strategic alternatives announcement. Since then, the REIT’s stock price had by Wednesday grown more than 40% to $6.25.
The post-rally price more closely reflects the value of the company’s properties, said Vikram Malhotra, managing director at Mizuho Financial Group, who has an outperform rating on the stock.
“The underlying value of assets in the private market is certainly richer than what was implied, and this is just closing that gap,” he said.
Paramount Group owns office towers in New York and San Francisco that its executives believe the market has undervalued.
The lack of price movement in the broader REIT environment is despite apartment owners working through a historic level of new development, retail REITs achieving and maintaining high occupancy, and investment in artificial intelligence fueling massive levels of data center development.
In 2024, REIT operators with cash to spare responded to the lack of investor excitement with stock buybacks. Life sciences-focused REIT Alexandria Real Estate Equities announced a $500M repurchase program in December, despite reports that new supply was outpacing demand.
“In real estate, tenant credit and the ability to pay rent is always a question,” Malhotra said.
Negative perceptions of market dynamics can weigh on REIT valuations as much as the sector’s actual performance, widening the gulf between public and private valuations, as in Paramount’s case.
“There is a disconnect, and when that disconnect gets wide, that’s when you see private [investors] saying, ‘Well, I can take this vehicle private, perhaps sell pieces of it, realize more value over time and bring it public again,’” Malhotra said.
Franklin Street Properties, an office REIT with a primarily Class-B portfolio of roughly a dozen properties, announced its review of strategic alternatives on May 14, immediately boosting the stock by 25%. Analysts at Janney Montgomery Scott responded with skepticism, saying it was unlikely that the REIT would draw bids much above its current price of $1.85 per share, citing softness in the office market.
“However, if we are wrong and an offer meaningfully north of $2 is forthcoming, we believe it would have a major impact on the entire office REIT space,” Janney analysts wrote.
Generation Income Properties, a net lease REIT with roughly 600K SF in assets, announced its review along with a $2.7M net loss for the first quarter on May 19. Investors were unmoved, with the stock roughly flat since the start of the month at $1.60 per share.
The bullish case for commercial real estate revolves around supply, Goldfarb said. The wave of pandemic-era construction is coming online, but construction starts across most sectors dried up as the Federal Reserve raised interest rates.
Macroeconomic uncertainty and a trade war have further weighed on construction starts, and private investors that aren’t publicly reporting quarterly results can afford to be more patient as they wait for the current inventory to be absorbed.
“If you’re private equity or some private institution and you want inflation protection and growth, real estate right now is an amazing investment,” Goldfarb said. “If [a REIT’s] stock is trading below where private market values are trading, there’s an arbitrage there.”
The perceived size of that valuation gap will drive transactions and more private takeouts in 2025, but it is unclear to what degree. Huge amounts of capital have been sitting on the sidelines for the better part of two years, waiting for discounted deals that have failed to materialize at scale. It is an open question whether private capital wants what public REITs are selling.
“There’s always hope. Everyone who starts a round of golf is going to shoot par,” Goldfarb said. “First hole goes, you’re two-over. Next hole goes, you’re three-over. And then, suddenly, reality starts setting in.”
