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(Illustration by Daniel Hertzberg)
The recent bidding war for LaSalle Hotel Properties has played out like a high-stakes poker match. The price tag for the real estate investment trust — which owns 41 U.S. hotels — shot up nearly $2 billion in just 12 weeks.
Pebblebrook Hotel Trust made an unsolicited offer for the rival company in late March, valuing it at roughly $3 billion. But as other potential buyers jumped into the fray, Pebblebrook increased its bid four times over the next three months to $4.17 billion.
Finally, LaSalle announced in May that it would accept $4.8 billion from the Blackstone Group. Determined not to lose out on the deal — which still requires approval from two-thirds of LaSalle’s shareholders — Pebblebrook upped its existing stake in the company to 9 percent.
The drama harkens back to the last time the industry saw such a deluge of mergers and acquisitions activity, in 2007. Back then, it was Blackstone and Vornado Realty Trust facing off in a knock-down, drag-out battle to buy Equity Office Properties.
“It’s been more exciting,” said Matt Kopsky, a REIT stock analyst at financial services firm Edward Jones. “[Activity] does seem to be picking up, and there’s sort of an appetite for it … it’s hard to see that changing in the current environment.”
Welcome to real estate’s new age of mergers and acquisitions.
M&A activity among real estate firms hit $524.7 billion last year — nearly 25 percent more than the 2007 record of $424.5 billion, according to figures from Thomson Reuters.
REITs, residential and commercial brokerages and private firms alike are all hunting for companies to buy as a way to boost their bottom lines.
In March, for example, Brookfield Property Partners entered an agreement to buy GGP for $15 billion. That came shortly after its failed bid for Forest City Realty Trust.
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In late May, Newmark, fresh off its initial public offering, announced it would scoop up retail powerhouse RKF. And on the residential front, Compass has dug into its deep pockets to make a series of acquisitions nationwide this year.
Experts say that record levels of private equity money waiting to be deployed are a driving force behind these deals. That, coupled with a growing belief that the end of the bull run is near, is creating a heightened sense of urgency. Also fueling these purchases is uncertainty in some sectors.
“The most difficult time to merge or acquire is during a very, very strong market,” said David Birnbrey, co-CEO of the Atlanta-based Shopping Center Group, who in 2012 merged his company with White Plains-based Northwest Atlantic Real Estate Services. “The easiest times are during a down market, because companies don’t like interruption. If things are going great, they don’t like interruption.”
Money to burn
Thanks to SoftBank, a handful of budding companies have grown war chests virtually overnight. Last year alone, the Japanese conglomerate pumped nearly $6 billion into real estate firms.
WeWork is one of the lucky ones.
Since SoftBank’s $4.4 billion cash infusion drove the company to a $20 billion valuation last year, the co-working firm has been gobbling up office space along with buildings and ancillary startups.
In March 2017, WeWork launched a $400 million real estate investment fund with the Rhone Group. In November, that fund paid $850 million for WeWork’s new global headquarters at Lord & Taylor’s flagship on Fifth Avenue. The company has also bought the Flatiron School and startups Meetup, a platform for organizing group events, and Conductor, a digital marketing company. (WeWork is reportedly now in talks for another funding round led by SoftBank, which could nearly double its valuation.)
Through its $100 billion Vision Fund, SoftBank has shown a pronounced interest in real estate, also funneling money into Compass, construction startup Katerra and home insurance provider Lemonade.
But while SoftBank may be the industry’s biggest kingpin, it’s not the only one throwing money at real estate.
“[There is] about $180 or so billion of private equity dry powder that’s been raised and targeting real estate,” said Mitch Germain, a REIT analyst with JMP Securities. “I think that’s just driving more and more money into the commercial real estate sector.”
Across all industries, there is around $1.8 trillion in capital that’s fanning this M&A craze, according to the consulting firm McKinsey. At the start of 2017, there was a record $516 billion earmarked for buyouts, according to the financial management consultancy Bain & Company.
And real estate’s just a drop in the bucket.
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In 2017, there were more than 50,000 mergers for the third year running, according to Thomson Reuters. That included monster deals like AT&T and Time Warner’s tie-up, Disney’s proposed acquisition of 21st Century Fox and Amazon’s buyout of Whole Foods.
But amid heavy competition for standard real estate deals and an oversaturation of financial technology — or fintech — plays, investors are looking for new places to park their cash, according to Zach Aarons, a co-founder of MetaProp, a New York real estate tech accelerator that just raised $40 million.
That’s driven investors’ interest in real estate’s nascent “PropTech” space.
So far in 2018, investors have poured more than $500 million into real estate tech, according to Aarons. That puts PropTech companies on track to raise a total of $1 billion this year.
Last fall, for example, Boston-based private equity firm Thomas H. Lee Partners shelled out more than $1 billion for the online real estate marketplace Ten-X, which handles around $10 billion in residential and commercial sales annually and also owns Auction.com.
The cash infusion gave the site the “scale and resources” to accelerate growth and continue to monetize its platform, Ten-X’s CEO, Tim Morse, said at the time.
For firms with brick-and-mortar real estate exposure, investing in real estate tech is especially beneficial since they can use the technology in their own businesses.
And make no mistake, these M&A deals, coupled with the venture cash flooding the industry, are having major impacts in every corner of the business.
Compass has disrupted the traditional residential brokerage model, and its ability to raise massive sums of money has turbocharged its growth. Even before sewing up $450 million from SoftBank in December, CEO Robert Reffkin said Compass was aiming to have 20 percent market share in 20 major cities by 2020.
The funding is earmarked for the company’s physical expansion — things like offices and technology, said Rob Lehman, Compass’ chief growth officer.
But in the past six months, the firm has also picked up eight brokerages — including two in the Chicago area: Conlon Real Estate, a 300-agent firm, and Hudson Company, with some two dozen residential brokers.
“M&A is just one part of our core strategy,” Lehman said. “There’s no question that there have been more acquisitions.”
In this environment, traditional players have had to recalibrate and up their game to compete — whether that means offering agents higher commissions, rolling out better technology or buying rival companies themselves.
For years, Douglas Elliman had been actively recruiting agents — and shopping for acquisitions — to boost its footprint on the West Coast. But when Compass launched an office in Beverly Hills two years ago, sources said, Elliman was under intense pressure to move quickly.
Elliman acquired Beverly Hills-based Teles last year for an undisclosed sum. The deal gave Elliman a total of 630 agents and 21 offices in the area and made it a regional powerhouse overnight.
The firm also bought Boston-based Otis & Ahearn last year, absorbing 30 agents and 25 new condo projects.
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“Organic growth is very expensive, and it takes a very long time,” said Scott Durkin, Elliman’s president and COO. “An acquisition is immediate; you have immediate market share and a stable of agents that come along with it.”
Still, Elliman’s expansion plans are small potatoes compared to Warren Buffett’s HomeServices of America — an affiliate of Berkshire Hathaway — which became the second-biggest brokerage nationwide after gobbling up smaller rivals over the past few years. (Only Realogy — which owns Coldwell Banker and the Corcoran Group — is larger, with a market cap of $2.9 billion.)
In September, HomeServices scored a coup by buying Washington, D.C.-based Long & Foster, one of the country’s biggest residential firms, with 11,000 agents, 230 offices and $29 billion in 2016 deal volume.
HomeServices targeted the New York region last year with its acquisition of Houlihan Lawrence, which was Westchester’s largest firm, with 1,300 agents.
HomeServices has since opened its own office in Manhattan, though it hasn’t gained much traction and only has around 50 agents.
It has, however, been rumored to be shopping for an independent firm here. Sources said it met with Brown Harris Stevens last year, but a deal never materialized.
And Buffett’s appetite for real estate is far from sated. “Despite its recent acquisitions, HomeServices is on track to do only about 3 percent of the country’s home-brokerage business in 2018,” he wrote in his annual letter to shareholders. “That leaves 97 percent to go.”
Trimming the fat
A few years ago, analysts were predicting that consolidation would sweep the industry, which had exploded with new firms during the economy’s recovery. That day has now arrived.
And in addition to chasing growth, it’s also been fed by business inefficiencies.
“I think consolidation is definitely the buzzword right now,” said SCG’s Birnbrey. “The cost of technology and analytics and research and data are increasing. [Companies are] finding that if they can combine forces they create economies of scale, they eliminate redundant activities.”
Warehouse providers Prologis and DTC Industrial Trust’s $8.4 billion merger is a case in point. Together, the companies will control a 71 million-square-foot national portfolio during a time when e-commerce is driving up values for distribution centers.
The two expect to save $80 million in the near term, and Prologis Chief Executive Hamid Moghadam said they would generate more revenue together than apart — largely because they had the same customer base. “Between the two of us, we have a bigger share of their wallets,” he told the Wall Street Journal.
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As an increasing number of companies eye mergers through that same prism, full sales alone are not the only option.
David Sturner, president and CEO of MHP Real Estate Services, said the desire for efficiency is what led to the sale of 60 percent of the company to Miami-based Banyan Street Capital this year.
When raising its sixth general-partner fund a year and a half ago, investors wanted more control over how MHP would invest. Sturner said that would have made it harder to go after off-market deals aggressively. Investors were willing, though, to give MHP more discretion if the family sold them all —or part — of the company
MHP resisted at first but eventually struck a deal with Banyan, which gives the company a steady stream of capital to invest and $3 billion in combined assets. “It made sense for us to not ever stop transacting,” Sturner said.
Bruce Stachenfeld, a founding partner of law firm Duval & Stachenfeld, said these so-called “platform deals” — where one company buys into another’s business — are similar to what a joint venture or sponsor would put together for a single property, but “on steroids.”
“These transactions are very in vogue right now,” said Stachenfeld, adding that there are an “enormous number of devils in the details.”
“They’re very tricky deals,” he said. “They’re traps for the unwary.”
Mergers, however, can be a painful process, often involving layoffs, office closures and the blending of two diverse company cultures. And there have been a slew of notorious failed mergers over the last few decades, including America Online’s $165 billion acquisition of Time Warner in 2001; Sprint’s $35 billion stock acquisition of Nextel Communications in 2005; and News Corporation’s $580 million purchase of MySpace, also in 2005.
In addition, the number or failed mergers — or those that never closed — hit 7.2 percent in 2016, the fourth-highest level in the 25 years up to that point, according to a study out of the City University of London’s Cass Business School. The study attributed that to high transaction prices and political uncertainty.
But the general consensus is that if done right the upside can outweigh the downside.
In 2016, for example, VTS and Hightower, two cloud-based leasing and management platforms, merged in a deal valued at $300 million. At the time, VTS CEO Nick Romito said the combined company could scale more rapidly, and he compared the deal to Zillow and Trulia’s merger, which followed years of fierce rivalry. “We just got to the decision a lot earlier,” he told the Wall Street Journal at the time.
With larger firms and investors on the prowl, small and midsized companies are merging to mount a better defense. That’s especially true in the residential brokerage world, with firms looking to counter high fixed costs like rent, technology and bigger commission payouts.
“There’s a very high cost of doing business right now, and if your business is small, it’s hard to afford the rent, the advertising, the marketing and the agent perks,” said Elliman’s Durkin. “You just can’t compete with the big players.”
Last year, City Connections Realty and DSA Realty — both midsized players in Manhattan — merged to achieve greater economies of scale, according to DSA’s Arik Lifshitz. At the time of the deal, he said he’d “reached the limits of where I can take the firm on my own.” (In addition to its 128 rental building exclusives, 35 of DSA’s agents joined City Connections, which had 130 exclusives and 95 agents at the time of the deal.)
Then, last month, City Connections absorbed NoMad-based Aventana Real Estate, a five-person firm with 40 rental exclusives. “It’s all about cutting out most of the expenses and just keeping your productive agents with you, especially in today’s brokerage climate,” said David Schlamm, who founded City Connections in 1988.
Schlamm said he’s currently in talks to merge with another half-dozen small firms.
“I don’t have the big, sexy brand with a quarter of a billion dollars behind me,” he said, “but I do know how to run a company.”
In a similar vein, Oxford Property Group merged last year with Titan Real Estate, owner of the Hecht Group brokerage.
“We were operating two very similar business models, with very similar expenses,” said Adam Mahfouda, who co-founded Oxford in 2010. The combined firm has 475 agents, and Mahfouda said it’s saving between $300,000 and $500,000 a year, including $200,000 in rent after Hecht shut its office.
According to Mahfouda, the combined company brokered $350 million worth of rentals and sales in 2017. Oxford alone did $175 million worth of deals in 2016.
“Douglas Elliman doesn’t have to merge, because they’re already an established brand,” Mahfouda said. “It’s important for smaller companies that don’t have an established brand to make a larger decision and bring themselves into a larger brand to grow as a company.”
Discount deals
Regardless of a company’s structure, a firm’s value often boils down to the health of the market.
REITs, for example, have been trading at a discount compared to the net asset value (NAV) of their properties as investors pull back amid fears of higher interest rates.
“We’ve seen REITs trade anywhere between 10 to 15 percent NAV discount,” JMP Securities’ Germain said. “You have this disconnect of the public companies trading at a discount to private-asset valuations.”
That new market reality is feeding the deal pipeline.
Brookfield Property Partners, for example, is finally reeling in a fish it has been trying to catch for more than two years. In March, the company announced it would pay $23.50 per share to buy the 66 percent of mall owner GGP that it didn’t already own.
Brookfield’s interest in buying the remaining shares of GGP dates back to 2016, when it was rumored to be sniffing around for an acquisition. While the deal didn’t materialize back then, Brookfield has since upped its stake in the company. Today, the consensus on Wall Street is that Brookfield is buying GGP at a discount.
Ben Brown, the head of Brookfield’s New York and Boston region, said the GGP deal presents the opportunity to reinvent the company’s real estate, either through repositioning properties or by adapting to changes in the retail market.
“We think the market is going through, clearly, a lot of turbulence,” he said. “I think it’s a period of redefining retail.”
The cooler residential market has also fueled more deal-making among brokerages that would be under less pressure to act in a stronger market.
In addition to impacting deal flow, those market forces have skewed the purchase price of some recent acquisitions.
“Historically, we’d look at a company and its EBITDA [earnings before interest, taxes, depreciation and amortization] and then apply a multiple of that,” said Elliman’s Durkin. “These days, in each city the market is different. You may have to give more value based on the fact that they have more market share, [even though] the bottom line is not as healthy.”
In some markets — like Los Angeles — extremely high agent-commission splits are a drag on profitability. “If you have enormous market share, you can make your money with other services,” Durkin said.
The valuation situation
The industry’s research firms offer something of a crystal ball for what’s on tap for this M&A craze.
Colorado-based Real Trends, which works with residential firms nationwide, is handling double the valuation work from two years ago, said founder Steve Murray. The firm, which valued 200 brokerages in 2017, is on track to value 270 this year.
“In one week in April, we had 27 requests for valuations,” said Murray, who’s actively advising 16 companies looking to be bought.
He’s also been engaged by private equity shops that are actively seeking brokerage investments.
He attributed that, in part, to venture-backed firms like Compass (now valued at $2.2 billion) and Redfin, the discount brokerage that went public last year (now valued at $1.8 billion.)
“A company like Compass or Redfin, they see this and say, ‘You don’t have to have 30 percent of this market, because it’s a $74 billion revenue industry where the largest franchise only has 10 percent share and the largest wholly owned brokerage has 3 percent,’” Murray said.
Given competition from mega-brokerages and real estate conglomerates, it seems unlikely that the wave of consolidation can be reversed.
Jeff Detwiler, president and CEO of Long & Foster, said the landscape has shifted dramatically since the firm launched in 1968.
For its part, Long & Foster has announced several acquisitions since it was purchased by HomeServices, including a brokerage in Washington, D.C., and a large property management business in Northern Virginia that gave it 7,500 units. The company also has robust mortgage and title insurance businesses.
Detwiler said diversification is one strategy for dealing with constraints on the brokerage firm’s profitability.
“There are a lot of people in the industry who are reevaluating that now,” Detwiler said.
And many firms see getting acquired as their best bet in this unforgiving environment.
“A lot of small companies come to us and say, ‘What about me?’”
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In late May, Newmark, fresh off its initial public offering, announced it 
