2019 Real Estate M&A Outlook Building momentum · • Real estate investment trust (REIT) M&A...
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2019 Real Estate M&A Outlook Building momentum
Transcript of 2019 Real Estate M&A Outlook Building momentum · • Real estate investment trust (REIT) M&A...
2019 Real Estate M&A OutlookBuilding momentum
Brochure / report title goes here | Section title goes here
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ContentsOverview and outlook 1
2018 year in review 2
Looking forward: 2019 outlook by sector 4
Office 5
Industrial 6
Retail 7
Hotel/leisure 8
Residential 8
2019 real estate M&A drivers and trends 9
Moving forward: 2019 real estate M&A opportunities 18
2019 Real Estate M&A Outlook | Building momentum
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Overview and outlook
Favorable global trends, a positive investment climate, and opportunities from technology-driven industry disruptions are building momentum for an active commercial real estate (CRE) mergers and acquisitions (M&A) environment in 2019:
• Global CRE volume continues to climb, with the United States the most attractive CRE investment destination. In addition, foreign investors are increasing their investments in CRE debt as they seek diversificationfromexposuretopotentiallymoderatingassetprices.
• Thethreatofarisinginterestrateenvironmentismoderatingandisalsobeingoffsetbystrong CRE fundamentals.
• Real estate investment trust (REIT) M&A activity continues to increase. Several REIT asset classes are tradingatasignificantdiscounttonetassetvalue(NAV),withregionalmallandshoppingcenterREITstrading at the largest discounts. The self-storage sector is trading at the largest median premium.
• IndustrialREITscontinuetogetahighpremiumduetostrongfundamentals,growthexpectations, and demand.
• Adigitalanddata-drivenmarketplaceisattractinginvestorstotech-enabledCREfirmsandgeneratingdisruptive M&A opportunities, as brick-and-mortar real estate owners realign to the internet economy andoffice/industrialinvestorsconsiderthechangingnatureofworkandtenantpreferences.
As detailed in Deloitte’s 2019 Commercial Real Estate Industry Outlook,surveyresultsof500globalinvestors,whichprovideinsightsonfactorsthatareinfluencingtheirCREinvestmentdecisions,are also encouraging:
• A large proportion of respondents plan to increase their capital commitment to CRE, with the United States, Germany, and Canada leading the way.
• Nontraditionalassets,suchasmixed-useprojects,andnewbusinessmodels,suchaspropertieswithflexibleleasesandspaces,areexpectedtoattractanincreasedallocationofinvestmentdollars.
• Manysurveyedinvestorsexpecttoprioritizetheirinvestmentsinexistingandpotentialinvesteecompanies that respond rapidly to changes in business models and adopt a variety of technologies to make buildings future-ready.
• Surveyrespondentsseeasignificantimpactfromtechnologyadvancementsonlegacypropertiesinfewer than three years.1
Thisreportlooksbackat2018andexamineskeytrendsfor2019tohelpCREownersandinvestorsplantheirM&Astrategyastheypositiontheirorganizationstoadaptandgrowforthefuture.WhileourprimaryfocusistheUSCREmarket,wealsoexamineissuesandtrendsthatareinfluencingindustryM&Aon a regional and/or global basis.
Ninety-seven percent of respondents in a recent Deloitte survey plan to increase their capital commitment to CRE over the next 18 months, with the United States, Germany, and Canada leading the way.2
“
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2019 Real Estate M&A Outlook | Building momentum
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Global CRE volume continued its upward trend in 2018, bolstered by steady economic and employment growth in key global markets. The trend moderated a bit in the year’s second half due to some global uncertainty and slowing growth in China. Transaction volume increased3.5percentyearoveryearto$733billion(seefigure1).3 The Americas were the top CRE market in terms of volume growth, postinginvestmentvolumeof$281billion(+13percentyearoveryear). APAC was up 7 percent year over year even with the drag from China(figure1).4
2018 year in review
Figure 2 Top 10 2018 real estate deals
Top 10 global transactions
Across industry segments and property types, a sample of the most notable2018USrealestatetransactionsrangedinvaluefrom$1.8billionto$28billion(seefigure2).
Figure 1 Global CRE volume continued its upward trends in 2018.
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285
245
149
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EMEAAmericas
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-13% 13%
-6%
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APAC
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Source: JLL Global Capital Flows, Q4 2018
2016 vs 2017 vs 2018 (US$ billion)
Announced Acquirer Acquirer nation Target
Target nation
Target sub-sector
Value ($B)
04/26/18 Two Harbors Investment Corp. US CYS Investment Inc. US REITs 11.5
07/31/18 BrookfieldAssetManagementInc. Canada Forest City Realty Trust Inc. US REITs 11.4
04/29/18 Prologis Inc. US DCT Industrial Trust Inc. US REITs 8.1
05/07/18 BlackstoneRealEstatePartnersVIIILP US Gramercy Property Trust US REITs 7.2
05/02/18 Annaly Capital Management Inc. US MTGE Investment Corp. US REITs 5.6
06/18/18 WPCareyInc. US Corporate Property Associates 17-Global Inc. (remaining 96% interest) US REITs 5.5
03/28/18 Pebblebrook Hotel Trust US LaSalle Hotel Properties US REITs 5.4
01/29/18 Investor Group1 China DalianWandaCommercialPropertiesCo.Ltd. (14.273% stake) China Other Real
Estate 5.4
02/15/18 Choice Properties Real Estate Investment Trust Canada Canadian Real Estate Investment Trust Canada REITs 4.6
06/28/18 Lone Star Fund X(US)LP US CaixaBankSA-RealEstateBusiness (80% of ownership interest) Spain REITs 4.6
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In terms of inbound transactions, the United States continues to be the most preferred CRE market globally, followed by Hong Kong andChina(seefigure3).Thesethreecountriescomprisenearly50percent of total inbound investment.
2019 Real Estate M&A Outlook | Building momentum
Top 10 US transactions
Figure 3 Globally, the Unites States, Hong Kong, and China are most favored CRE markets
Source: Deloitte Center for Financial Services analysis
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Hong Kong
China Canada
Singapore
Japan
UK
Germany
Austria
Brazil Other 1%
20%
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15%8%
8%
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WhenDeloittesurveyedglobalrealestateinvestorsabouttheirprimaryobjectivefordoingdealsintheUnitedStates,respondentscited the potential for higher returns, the breadth of the market and liquidity, a stable economic environment, and a preference for new and emerging business models.5
Corroborating the United States’ popularity as a CRE investment destination, 86 percent of respondents to an Association of Foreign Investors in Real Estate (AFIRE) survey said they planned to maintain or increase their investment in US real estate in 2018.6 Respondents cited several strengths of the US market, including a strong and stable economy, transparent capital markets, and a reputationforinnovation.Inaddition,about50percentofAFIREsurveyrespondentsfeelthatUSrealestatepricesarelessexpensivethan their home market. The United States also continues to lead theworldintermsofofferingthebestopportunityforcapitalappreciation,followedbyBrazilandChina.
Foreign investors showed keen interest in alternative asset classes includingseniorhousing,infrastructure,medicalofficebuildings, and student housing. There is also increasing foreign investment in CRE debt.
Source: JLL Global Capital Flows, Q4 2018
Announced Acquirer Acquirer nation Target
Target sub-sector
Value ($B)
04/26/18 Two Harbors Investment Corp. US CYS Investment Inc. REITs 11.5
07/31/18 BrookfieldAssetManagementInc. Canada Forest City Realty Trust Inc. REITs 11.4
04/29/18 Prologis Inc. US DCT Industrial Trust Inc. REITs 8.1
05/07/18 BlackstoneRealEstatePartnersVIIILP US Gramercy Property Trust REITs 7.2
05/02/18 Annaly Capital Management Inc. US MTGE Investment Corp. REITs 5.6
06/18/18 WPCareyInc. US Corporate Property Associates 17-Global Inc. (remaining 96% interest) REITs 5.5
03/28/18 Pebblebrook Hotel Trust US LaSalle Hotel Properties REITs 5.4
06/25/18Greystar Student Housing Growth & Income Fund LP
US Education Realty Trust Inc. REITs 4.3
04/25/18 WelltowerInc. Canada Quality Care Products REITs 4.6
09/17/18 Government Properties Income Trust US Select Income REIT(remaining 72.177% interest) REITs 4.6
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Weexpect2018’srealestateM&Awinnerstoagainleadthewayin 2019. Retail and lodging, last year’s top-performing sectors (see figure4),shouldcontinuetogenerateamajorshareofdealvolumedue to their attractive valuations and appeal to opportunistic investors. Meanwhile, real estate buyers looking to add the “last mile”
Looking forward: 2019 outlook by sector(e.g., storage space) to their portfolios should drive increased M&A in warehouses/logistics/storage, which are likely to continue to demand the highest premiums in terms of value.
Figure 4 Retail and lodging lead US real estate M&A activity by sector
WhileweseemomentumbuildingtosupportanactiverealestateM&Amarketin2019,eachofthemajorassetclasses—office,industrial,retail,hotel/leisure,multifamily,andresidential—islikelytoexperienceoneormoremarketdisruptionsthatmayinfluenceM&Avolume and value.
Retail
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Other
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Diversified Healthcare
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10%8%
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Sources:Publicfilings,SNL,CapitalIQ,JefferiesLLC.,NAREITNotes:TransactionsinvolvingUSrealestateentitiesbetween2015and2017.2018YTDvaluesarebasedonrecentlyannounced transactions that have not yet closed as of 7/2/2018.
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Office
Manyofficesectorstakeholdersremembertheglorydaysoftheearly2000s,whentheofficeassetclassdominatedrealestateM&Aactivity.Today,whilestillstronginselectcities,theofficesectorlags
otherassetclasses;however,theuntappedpotentialofsharedoffice/co-workingspacesisgeneratingsignificantinvestmentinterestfromtraditionalandnontraditionalrealestateinvestors(seefigure5).
Figure 5 Shared office/co-working trend is disrupting office M&A
Distribution of co-working spaces by region and type
Global demand and supply
PE investments in co-working spaces
Sources:Global Co Working Forecast – Small Business Labs December 18, 2017Why big corporations are moving into Coworking Spaces – Andrew Broadbent
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Ucommune MyDream Plus
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WeWorkKnotel CIC Industrious
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(*)RestofWorld–Africa,SouthandCentralAmerica(includingMexico),EasternEurope,andCanada.(**)Non-office,non-makerspacessuchassharedkitchen,biolabs,etc.
2019 Real Estate M&A Outlook | Building momentum
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Several demographic and economic drivers are converging to disrupt thetraditionalofficespacemarket,includinganincreaseinself-employedprofessionalsandamoreflexible,globalizedworkforcesupportedbytechnologyinnovations;cost-consciousorganizationsseekingtotrimfacilitiesexpenses;largeglobalorganizationslookingtomatchofficespaceneedswiththepreferencesofayounger,more mobile workforce; and large demand-supply and investment gaps.CREexecutivesintheDeloittesurveysaytheyplantodiversifytheir portfolios through higher investments in newer and emerging businessmodelsandthematicinvestments(e.g.,flexiblespacesandleases);theyappeartorealizethattheirinvestmentsshouldbetiedto the changing nature of work and tenant preferences.7
Sharedoffice/coworkingisanticipatedtobringaboutaparadigmshiftinleasing,propertymanagement,valuations,andfinancing.Already, nimble startups are leveraging private equity investments and their own resources to pursue innovative acquisition and partneringdeals.Forexample,US-basedcoworkingspaceownerWeWorkhasbeenacquiringcompaniesatarapidpace,withfourtransactions in 2018 alone:8 Shanghai-headquartered rival naked Hub9(partofWeWork’scontinuedexpansionoutsideoftheUnitedStates); SEO and digital marketing startup Conductor;10 workplace software and analytics company Teem;11 and education startup MissionU.12Sinceitsinceptionin2010,WeWorkhasgrownfromasinglespaceinNewYorkCityto287physicallocationsacross77cities and 23 countries globally. The company’s growth outstrips many traditional CRE companies.13
Coworking spaces are moving beyond catering to startups and the small business sector; some of the world’s largest companies arerentingWeWorkspacesfortheiremployeesandtestingmoreinvolvedpartnerships.WeWorknowmanagesentirebuildingsforvariousglobalFortune500companies.
Industrial
The industrial sector continues to post the real estate industry’s highest transaction premiums due to its strong fundamentals, growthexpectations,andbuyerdemand.Inaddition,thetraditional warehousing segment is undergoing a technology-driven transformation that is attracting investment interest by venture capitalandPEfirms.
As e-commerce brings warehouses closer to the end customer, retailers’ demand for “last mile” storage space is accelerating, eventhoughdevelopersmayhavedifficultyfindinglandfornewwarehousesinincreasinglycrowdedandexpensivecities.14Newwarehousesarelarger—PrologisrecentlybuiltthefirstUSmulti-storyfacilityjustoutsidedowntownSeattle15—androboticsandartificialintelligence(AI)arebringingabouthugechangesinthewaywarehousesaresetupandoperated.SeveralFortune500companies are testing robotic technology in warehouse operations and industrial REITs.
2019 Real Estate M&A Outlook | Building momentum
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Figure 6 Brick and mortar retail is in rightsizing mode
Retail penetration
Effective retailers are giving customers a curated experience
Sources: IsUSoverretailed?May15,2017NationalRealEstateInvestorAmerica’s“RetailApocalypse”IsReallyJustbeginning–November8,2017,Bloomberg,GGPInvestorPresentation
Retail
AttractivediscountstoNAVhelpedtheretailsectorleadUSrealestateM&Aactivityin2018.WeexpectretailM&Avolumetoremainhealthy in 2019, as traditional brick-and-mortar searches for a “new normal” in a dramatically changing industry. The boom in online shopping is driving the transformation of these physical assets into communitydestinationsthatrightsizetheretailfootprintandattractnontraditional tenants such as gaming centers, bowling alleys, and breweries.
Yet, despite a retail penetration rate far higher than other countries (seefigure6)andpersistentannouncementsaboutstoreclosures,brick-and-mortar retail is not dead. Savvy merchandisers are embracingtechnologyandcombiningtheironlineandofflinestrategiestogivecustomersapersonalized,curatedexperience.Many of these retailers may turn to M&A and partnering for the capabilities and scale they’ll need to succeed in both online and offlinemarkets.
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Curating the retailing experience
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environment
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Hotel/leisure
The hotel and leisure space is more fragmented than other REIT sectors; this opens the door to 2019 M&A in the form of large REITconsolidations.Wealsoexpecttoseeacquisitionsbysinglecompanieslookingtoexpandtheirinventoryandgeographicalfootprint.Forexample,home-sharinggiantAirbnb,whichdidnothavesignificantacquisitionsin2018(although,inaminordeal,itdid acquire Luckey Homes, a French concierge services/property management company, in December),16 started the new year with the purchase of Gaest, a Danish startup that provides a platform for people to post and book meeting venues in hourly or daily increments.17 Airbnb also appears to be interested in potential M&A thatwouldexpanditsofferingsintohotelbookings.18
One sector disruption that may drive technology-focused acquisitions or partnering agreements in 2019 is the increasing permeation of data analytics to improve revenue management and guestretentionprocesses.Forexample,the2018globalmergeroftheMarriottandStarwoodguestretentionprograms—nowcalledMarriottBonvoy—formsthefoundationforthelargestloyaltyprogram of its kind.19 Marriott Bonvoy is designed to improve the customerexperienceandprovidecompanymanagementwithbetter data on customer preferences and trends. Meanwhile, PE firmslookingforbetterinsightsintotheirexistinginvestmentsandpotentialacquisitioncandidatescontinuetoexpandandbroadentheir data analytics capabilities.
Residential (multifamily, single-family)
TheresidentialmultifamilysectoristradingatapremiumtoNAVentering 2019, which may begin to slow M&A activity. The high cost of initial home ownership is driving many would-be home buyers, particularlyMillennials,intothemultifamilyspaceformoreextendedperiods of time. This trend continues to drive up rents and add value to the multifamily sector. In addition, the high cost of big-city living is beginning to push some residents in larger markets to look for greenerpastures.Threekeyattributeswilldifferentiatesecondary-city destinations that attract Millennials’ interest: 1) knowledge hubs with a strong concentration of educational institutions and employment opportunities in high-skill industries; 2) markets offeringculturaldiversity;and3)lowercostoflivingthancitiessuchasNewYork,SanFrancisco,andChicago.
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Acrossrealestatesectors,executiveswhosecompaniesarecontemplatingM&Ain2019—whetherthatmeansselling,buying,investing,orpartnering—shouldplanforthefollowingtrendsthatmayeitherhelporhindertheirabilitytoexecuteontheirstrategicgrowth plans.
Global economic and political uncertainty
Escalatingpoliticaltensionsandongoingtariffandtradedisputesbetween the United States and its trade partners, particularly China, are raising concerns about a potential economic slowdown, ifnotafull-fledgedrecession,asearlyas2020.Someexpecttheeconomicstimulusfromfederaltaxcutsandadditionalgovernmentspending to peter out by 2020, while rising interest rates could perhaps discourage consumer borrowing, housing construction, and businessexpansion.20Vanguardrecentlywarnedthatthechancesforarecessionbylate2020are30–40percent.21 One warning sign citedbyeconomistswasaflatteningyieldcurvebetweenshort-andlong-terminterestrates—adevelopmentthathashistoricallyindicated a recession ahead.22
2019 real estate M&A drivers and trends
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Top 10 global real estate markets by investment volume (US$ Billion)
Early 2019 economic indicators also may be pointing to a slowdown: theWorldBankcutitsgrowthforecast;Apple’sdowngradedsalesforecast(whichledtoamarketsell-off)wasoneofseveralcompanies’ warnings of earnings issues; and China is investing hundreds of billions of dollars in its slowing economy.23 One indicator of China’s current economic softness is the decline throughout 2018 in domestic CRE investment and outbound investment from Chinese firms.Theinformationinfigure7representsthetrendthroughthefirsthalfof2018;investmentcontinuedtoslowthroughtheremainder of 2018. A continuation of these trends in 2019 may have several implications for global real estate M&A:
• China is second only to Canada in leading cross-border investments into the United States.24 If its outbound investment volume continues to lag, US inbound real estate investment may decline—unlessinvestorsfromothercountriestakeadvantageofless competition to make their own M&A plays.
• Foreign investors may become more active in China’s commercial real estate sector in place of domestic investment.
Another economic factor that has the potential to be either a positive ornegativeM&Ainfluenceristhewhipsawingstockmarket.Iffallingpricesandsell-offsextendfarinto2019,theymayspurrealestatecompaniesandfinancialinvestorswithstrongbalancesheetsto
scoop up distressed assets or, conversely, ratchet up corporate uncertainty and reduce M&A activity. Of the two possible outcomes, we anticipate an uptick in M&A, given current industry dynamics.
Figure 7 China lagging in 2018 global CRE investment volume
Top 10 global commerical real estate markets by investment volume (US$ Billion)
Source: JLL Global Market Perspective, August 2018
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Figure 8 PERE fundrasing and dry powder retain their momentum
Global annual closed-end private real estate fundraising
Source: Preqin Fund Raising Update 2018
PERE fundraising and dry powder
The boom in private equity real estate (PERE) fundraising has createdrecordlevelsofcapital—oftenreferredtoasdrypowder.Value-addedandopportunisticfundsaccountedfortwo-thirdsoffundclosuresandcapitalraisedin2018;thistrendisexpectedtocontinuein2019(seefigure8).
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2019 Real Estate M&A Outlook | Building momentum
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Note:Drypowderreferstocashreservesonhand,especiallytocoverfutureobligations
2019 Real Estate M&A Outlook | Building momentum
Source: Preqin Fund Raising Update 2018
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Figure 9 Global real estate debt fundrasing declined in 2018
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Source: Global RE Debt Fundraising sees 48% drop, recapitalnews.com, Jan 2019
2019 Real Estate M&A Outlook | Building momentum
The investments from these funds likely will be focused on value opportunitiesinsectorstradingatadiscounttoNAV,aswellasinemerging growth areas such as proptech and disruptive real estate plays in the industrial and other sectors. These investors will continue to use data analytics to drive their investment thesis, and those businesses that are able to provide quality data to support their growth strategies will have more success attracting this capital.
The surge in real estate debt funds hit a peak in 2017 and began to moderateinpopularityin2018(seefigure9).Weexpectthesefundsto continue to attract capital as CRE debt may provide a safer investment option for foreign investors, with less downside risk if/when prices fall.
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Deals include both public and private *Includes pending transactions
Source:Bloomberg,SNL,LaSalleInvestmentManagementSecurities.Dataasof6/30/2018.Accordingtothesesources,“thereisnoguaranteethistrendwillcontinue.”https://www.nreionline.com/reits/reit-ma-activity-match-or-outpace-last-year-s-level-2019-experts-predict
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Figure 10 US REIT M&A deal volume is rising but remains below pre-financial downturn levels
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REITStradingatanattractivediscounttoNAVisaprimarydriverofincreased M&A, as evidenced by several recent large transactions. Regional mall and shopping center REITs have traded at the largest discountstoNAV,whiletheself-storagesectortradedatthelargestmedian premium.
Value-focusedinvestorsconsideringREITsforM&A,jointventure,or partnering opportunities should leverage data-driven analyses to craft a robust strategy around current market positions and analyzehowexpansionintonewerpropertiescouldcomplementtheirexistingones.Strategylinkagedrivenbysupportingdatacanhelp demonstrate how a single REIT investment not only presents operational synergies but also evolves the broader portfolio. For instance, retail owners could conduct highest and best use analysis based on location, surrounding demographics, and other macro factors to repurpose some of their vacant assets into nontraditional uses such as data centers and senior housing and create new sources of revenue.25 Deloitte survey respondents also suggested
several ways that REIT investors can unlock value in the current market environment:
• Transformthebusinesswithtechnologyinvestmentstooptimizerevenues,reducecosts,andgenerateoperatingefficiencies
• Optimizeandrescalepropertyportfolios
• Consider private company status
• Change the capital structure of the entity by issuing additional debt or preferred equity
• Engage in M&A activities to acquire rivals or merge with others to achieve greater scale.26
REIT M&A activity
US REIT M&A volume and value are rising, although both remain well belowpre-financialdownturnlevels(seefigure10).
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2019 Real Estate M&A Outlook | Building momentum
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2018
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2Q 2014 2Q 2015 2Q 2016 2Q 2017 2Q 2018 F2Q 20202Q 2019 F2Q 2021 F2Q 2022 F2Q 20231.50%
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Moody’s AAA corporate %10 Year treasurySitus RERC IRR Moody’s BAA corporate %
2Q 2018, 7.80%
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2Q 2023 F, 7.25%
2Q 2023 F, 3.16%
Figure 11 Potential for continuation of increasing interest rate environment may shift returns from real estate
Source: Situs RERC 1Q 2018 and 2Q 2018 Flash Report
Despiteaflatteningyieldcurvebetweenshort-andlong-terminterest rates, which sometimes signals an approaching recession,27 itissignificanttonotethatrealestateoccupancyratesandrentgrowtharesolid;theredoesnotappeartobesignificant
overbuilding, overheating, or overleveraging; the domestic US investment environment is favorable; and foreign investors have a positive outlook about the US CRE market.
Interest rates may shift real estate returns
The potential continuation of an increasing US interest rate environment may result in a shift in returns from real estate M&A (seefigure11)andputsomestrainontransactionprices;however,strong industry fundamentals should continue to drive returns and attract investors in 2019. As the current cycle moves through its ninth year, it brings the potential for slowing growth in CRE returns
andfutureinterestrateincreases.Withlimitedcapitalappreciation,CRE will rely on income to drive total returns moving forward. Recent signs from the Federal Open Market Committee (FOMC) are for a more conservative stance on interest rates in 2019, thereby moderatingtheimpactonrealestatereturnsexpected/budgeted in late 2018.
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Tax reform and regulatory relief
TheUSTaxCutsandJobsActof2017(the“2017TaxAct”)introducedthemostcomprehensiveoverhaultotheUStaxsysteminmorethan 30 years. The changes were both broad (impacting businesses andindividuals)andsignificant(introducingmeaningfulchangestoexistingtaxlaw).Belowareahandfulofkeyprovisionsthatareexpectedtoimpacttherealestateindustryand2019M&Aplanningandexecution.
Interest deductibility: Followingtaxreform,netbusinessinterestis allowable as a deduction limited to 30 percent of a business’s adjustedtaxableincome(generallyequaltoEBITDApriorto2022;EBITthereafter).TaxpayersengagedinaRealPropertyTradeorBusiness (RPTOB), however, may make a RPTOB election that would allow net business interest to be fully deductible. The ability for an electingRPTOBtofullydeductinterestexpenseisfavorablefromanM&Astandpoint,astaxefficiencyonacquisitionleverageismaintainedandprovidesforflexibilityincapitalizingtransactions.
Depreciation—Immediate expensing for qualifying property: The2017TaxActallowstaxpayerstoimmediatelyexpensecertainqualifiedpropertyacquiredafterSeptember27,2017,andpriortoJanuary1,2023(afterJanuary1,2023,theabilitytoexpenseisphasedout20percenteachyear).Qualifiedpropertygenerallyincludes tangible personal property and land improvements with a recoveryperiodof20yearsorless.TotheextentanRPTOBelectionismade(asdiscussedabove),immediateexpensingispermitted;however,propertythatdoesnotqualifyforimmediateexpensing(e.g.,residentialandnonresidentialrealpropertyandqualifiedimprovement property) must be recovered over a longer period (using their respective ADS lives). From an M&A point of view, the abilitytoexpensecertaincapitalexpendituresisfavorableasitallowsforacceleratedtaxdeductionsresultinginareductionofcurrenttaxbills,therebyincreasingthepresentvalueofpotentialinvestmentsaswellasexpectedreturns.ForelectingRPTOBs,thebenefitisevengreaterbecausetheabilitytoclaimimmediateexpensing(offsetbylongerdepreciationoncertainotherproperty)iscoupledwiththeabilitytoclaimfullinterestexpensedeductions.
State and local tax itemized deductions capped at $10,000: Priortothe2017TaxAct,taxpayerswereabletodeductstateandlocaltaxes(includingincomeandpropertytaxes)whenitemizingtheirdeductions,subjecttoanoverallitemizeddeductionphaseout.Followingreform,taxpayersthatitemizetheirdeductionsarelimitedto$10,000withrespecttostateandlocaltaxes.Itisexpectedthat this will have a more pronounced impact on residential home ownershipinhigh-taxstates(e.g.,California,NewYork,NewJersey),effectivelymakinghomeownershipmoreexpensive;thismayleadto:(1)increased/continueddemandforresidentialrentalsinhigh-taxstates,and/or(2)increasedpopulationoutflowstolow-taxstates.
From an M&A standpoint, this could result in residential rentals in high-taxstatesandresidentialdevelopersinlow-taxstatesbecomingmore attractive.
Twenty percent deduction on qualifying pass-through businesses: The2017TaxActintroduceda20percentdeductionfor income earned from certain qualifying pass-through businesses. Certain real estate businesses appear to qualify for this deduction andmaybenefitfromthealternativelimitationcalculationallowingtaxpayerstoconsiderwagesandtheunadjustedtaxbasisofqualifiedproperty(asopposedtojustwages),therebymakingafter-taxreturnsmoreattractive.Inaddition,REITdividendsareconsidered qualifying income for purposes of the 20 percent pass-throughdeduction,resultinginabetterafter-taxreturntoshareholders and making REIT stock an attractive investment.
Qualified opportunity zones:Oneaspectoftaxreformthatdid not get much focus initially but has gained momentum in the industryisthenewlycreatedQualifiedOpportunityZones.Generally,taxpayersmaydeferandpartiallyreducecapitalgainstaxdueonthedisposition of property when such capital gains are reinvested in a QualifiedOpportunityZonethroughaQualifiedOpportunityFundwithinaspecifiedtimeperiod.
• Qualified Opportunity Zone (QOZ): A population census tract that is low income and has been designated by the governor (or otherchiefexecutiveofficer)asaqualifiedopportunityzone.
• Qualified Opportunity Fund (QOF):Aself-certifiedentitytaxedas a partnership or corporation that holds at least 90 percent of its assetsinQualifiedOpportunityZoneProperty(“QOZProperty”).
Institutionalinvestorsanddevelopers,aswellasfamilyoffices,areestablishingQOFstosolicittaxpayerswithunrealizedcapitalgainswho may be considering triggering such gains and investing in QOFs. This may lead to further opportunities for institutional investorstoexpandproductofferingsandincreasedevelopments in low-income areas.
Overall,astaxpayerscontinuetodigesttaxreformanditsimplicationsfortheircircumstances,weexpectthattheimpacttothe real estate industry and its deal-making participants should be favorable.
Also serving as an M&A enabler: a business-friendly regulatory environment. Regulatory barriers to M&A continue to fall, which isgoodnewsforwell-capitalizedcompanieslookingtorealestateinvestments or acquisitions as ways to boost inorganic growth. Legislators and regulatory agencies have been shifting their focusfromcreatingnewregulationstoreviewingandrefiningrequirementsthatarealreadyonthebooks.Weexpectthatpro-businesstaxandregulatoryconditionswillextendthrough2019.
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Proptech innovation
Proptechs—acollectivetermusedtodefinestartupsofferinginnovative, technology-driven products, services, or new business models for real estate markets28—areincreasinglypopularwithinvestors across the real estate value chain.29Proptechsuseexistingandemergingtechnologiestodevelopinnovativeofferingsthatenhanceoperationalefficiency,tenantexperience,andinformationflow.30 Solutions can include everything from construction and building materials, architectural design, and smart building automationtopropertymanagement,energy-efficientlandscaping,and smart contracts.31
Comparedwithitsbroaderfinancialservicespeers,partsoftherealestateindustry—forexample,pricing,mortgages,andbuildingmanagement—havebeenslowtoadoptsoftwarethatcouldmakebusinessmoreefficient.32 This, however, is changing. CRE leaders arerecognizingthataproptechrelationshipcanproduceawin-winsituation in which CRE companies match their industry knowledge
and business opportunities/needs with proptechs’ technology know-how and nimbleness.
Approximately$6billioninventurecapitalhasbeeninvestedglobally in proptechs since 2011; about 70 percent of that in 2016 and 2017.33 OpenDoor, one of the largest startups in the proptech category,raised$725millioninitsSeriesEfinancingin2018fromalonglistofventurecapitalists,includingSoftBank’sVisionFund,oneof the most aggressive investors in real estate tech startups.34 The volumeofproptechfinancinggloballyhasbeenonasteadyincrease,rising 36 percent year over year.35 And there is plenty of room for the sector to grow.36 On average, investors responding to Deloitte’s global CRE survey plan to commit 14 percent of their CRE capital to proptechs.37Weexpectproptech-relatedM&Awillproceedatabriskpace in 2019 and subsequent years. According to Deloitte survey results, CRE companies have several preferred options to engage with proptechs: investing, acquiring, collaborating, or using their services(seefigure12).
Invest in proptech companies
Percentage of respondents
31%
26%
20%
17%
4%
1%
Parner with proptech companies
Launch or participate in accelerators
Use proptech services
My company does not engage with proptechs
Other
Figure 12 CRE investors’ preferred modes of engaging with proptechs
Invest and partner are most preferred modes of engaging with proptechs
Percentage of respondents
Tomaximizeproptechdealvalue,potentialinvestorsshouldacknowledge and understand the potential transformation that proptechscouldbringtotheirorganization;developaclearstrategyand/or internal guidelines for engagement; develop a list of
decision-making criteria to guide proptech target selection; form a dedicated team to engage with proptechs; and identify metrics to measure success.38
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Strongindustryfundamentals,plentyofavailablecapital,taxreformand a pro-business regulatory environment, and the search for proptech capabilities provided a solid foundation for 2018 real estate industry M&A. Many of these positives remain in place for 2019; still, marketconditionsremaininflux,andtherearelikelytobeplentyofchallenges to overcome in the year ahead. Real estate companies andfinancialinvestorscontemplatingM&Atoboosttheirbottomline, broaden their portfolio, and strengthen future competitiveness should:
• Evaluate trends in their particular asset class and determine where market dynamics are creating tailwinds or headwinds.
• Conduct upside/downside scenario planning that accounts for, among other things, a potential economic slowdown and rising interestratesinthenext18–24months.
• Be clear on what they are solving for in evaluating organic/inorganicoptions(e.g.,scale,geographicexpansionanddiversification,data/techcapabilities,anopportunisticvalueplay).
• Develop an M&A strategy that supports what they are solving for and frames their appetite in approaching market opportunities.
• Select investment/alliance/acquisition targets that are consistent with the overall strategy, accretive, and synergistic. Avoid chasing a shinyobjectthatmaynotsupportlong-termgoals.
• Focus on high-quality properties in locations with strong fundamentals, conduct thorough diligence to identify what they do/don’t have of value and what could be carved out.
• Consider proactively reaching out to potential candidates to let themknowaboutinterestbeforeothersseizethemomentandtheacquisition becomes an auction situation.
• Bemindfulofthechangingtaxandregulatorylandscapeinbothdomestic and cross-border deals.
• Examineandpotentiallyenhancein-housecorporatedevelopmentandoverallintegrationcapabilitiestofacilitateefficientandsuccessful negotiations before embarking on deals.
Moving forward: 2019 real estate M&A opportunities
2019 Real Estate M&A Outlook | Building momentum
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Contacts
Anthony ScalesePartnerDeloitte & Touche [email protected]
Tom MorrisroePartnerDeloitteTaxLLP+12124366278tmorrisroe@deloitte.com
Thank you to the following individuals for their insights and contributions to this report:
Eva LeeSenior ManagerDeloitte Business Transactions & Analytics LLP
Mark SleighterManagerDeloitteTaxLLP
Authors
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Endnotes1. 2019 Deloitte Commercial Real Estate Outlook: Agility is key to winning in the digital era, Deloitte Center for Financial Services, 2018, https://www2.deloitte.com/us/en/pages/
real-estate/articles/commercial-real-estate-industry-outlook.html.
2. Ibid.
3. JLL Global Capital Flows, Q4 2018, http://images.interact.jll.com/Web/JLL/%7B231f4c5f-9383-4d33-a9a6-7920ab2a22ff%7D_GCF_Q4_2018_-_FINAL.pdf.
4. Ibid.
5. 2019 Deloitte Commercial Real Estate Outlook: Agility is key to winning in the digital era.
6. 2018 Association of Foreign Investors in Real Estate (AFIRE) Annual Survey, January 8, 2018, https://www.prnewswire.com/news-releases/london-edges-out-nyc-as-top-city-among-foreign-re-investors-300578452.html.
7. 2019 Deloitte Commercial Real Estate Outlook: Agility is key to winning in the digital era.
8. ShirinGhaffary,“WeWorkisonanacquisitionspree—andthey’reallovertheboard,”Recode,April12,2018,https://www.recode.net/2018/3/7/17086788/wework-acquisition-list-conductor-meetup-flatiron, accessed January 24, 2019.
9. RussellFlannery,“WeWorkbuysnakedHub,acceleratingChinaco-workingspaceconsolidation,”Forbes, April 12, 2018, https://www.forbes.com/sites/russellflannery/2018/04/12/wework-buys-naked-hub-accelerating-china-co-working-space-consolidation/#52028166763d, accessed January 24, 2019.
10. Ghaffary,“WeWorkisonanacquisitionspree—andthey’reallovertheboard.”
11. “WeWorkacquiresworkplacesoftwareandanalyticsleaderTeem,”WeWorksblog,September12,2018,https://www.wework.com/blog/posts/wework-acquires-workplace-software-and-analytics-leader-teem, accessed January 24, 2019.
12. “Exclusive:WeWork’sWeGrowacquireseducationstartupMissionU,”Fast Company, May 16, 2018, https://www.fastcompany.com/40572154/exclusive-weworks-wegrow-acquires-education-startup-missionu, accessed January 24, 2019.
13. 2019 Deloitte Commercial Real Estate Outlook: Agility is key to winning in the digital era;citingWeWorkwebsite,https://www.wework.com, accessed on August 20, 2018.
14. EricaE.Phillips,“PrologistobuildfirstmultistorywarehouseintheU.S.,”Wall Street Journal,November1,2016,https://www.wsj.com/articles/prologis-to-build-first-multistory-warehouse-in-the-u-s-1478019977, accessed January 26, 2019.
15. Ibid.
16. DeannaTing,“Airbnb’sdealforFrenchfirmcouldsignalentryintopropertymanagement,”Skift, December 12, 2018, https://skift.com/2018/12/12/airbnb-buys-french-property-services-firm-luckey-homes/, accessed January 27, 2019.
17. IngridLunden“AirbnbacquiresDenmark’sGaesttoexpandinbookingsformeetingsandoffsites,”TechCrunch,January25,2019,https://techcrunch.com/2019/01/25/airbnb-acquires-denmarks-gaest-to-expand-in-bookings-for-meetings-and-offsites/, accessed January 27, 2019.
18. Maureen Farrell and Greg Bensinger, “Airbnb has held talks to buy Hotel Tonight,” Wall Street Journal, updated January 18, 2019, https://www.wsj.com/articles/airbnb-has-held-talks-to-buy-hotel-tonight-11547838020, accessed January 27, 2019.
19. GeoffWhitmore,“DetailssurroundingtheMarriottandStarwoodmerger,”Forbes, April 18, 2018, https://www.forbes.com/sites/geoffwhitmore/2018/04/18/details-surrounding-the-marriott-starwood-merger/#38142a635c07.
20. 2019 Insurance M&A Outlook: Positioning for growth, Deloitte, 2019, https://www2.deloitte.com/us/en/pages/financial-services/articles/insurance-m-and-a-outlook.html.
21. JeffSommer,“Vanguardwarnsofworseningoddsfortheeconomyandmarkets,”New York Times, August 10, 2018, https://www.nytimes.com/2018/08/10/business/vanguard-recession-economy.html.
22. MattPhillips,“What’stheyieldcurve?‘Apowerfulsignalofrecessions’hasWallStreet’sattention,”New York Times,June25,2018,https://www.nytimes.com/2018/06/25/business/what-is-yield-curve-recession-prediction.html.
23. “DealBookBriefing:‘Forecastingaslowdown’for2019,”New York Times,January15,2019,https://www.nytimes.com/2019/01/15/business/dealbook/pge-banktruptcy-california-wildfires.html.
24. Jim Costello, “Cross-border investment in US edges up in Q1,” RCA, May 31, 2018, https://www.rcanalytics.com/us-cross-border-q118/.
25. 2019 Deloitte Commercial Real Estate Outlook.
26. Ibid.
27. Phillips,“What’stheyieldcurve?‘Apowerfulsignalofrecessions’hasWallStreet’sattention.”
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28. 2019 Deloitte Commercial Real Estate Outlook.
29. Ibid.
30. UrvashiVerma,“WhatisPropTechandhowisitchangingrealestateinvestment?”In-Building Tech, September 24, 2018, https://inbuildingtech.com/fundamentals/proptech-real-estate-tech, accessed January 22, 2019.
31. ErinGriffith,“Thehotpropertythat’snextontech’sagenda:realestate,”New York Times, updated September 27, 2018, https://www.cnbc.com/2018/09/27/heres-the-next-industry-tech-is-looking-to-disrupt-real-estate.html, accessed January 27, 2019.
32. PaulArmstrong,“5EmergingPropTechstartupsyouneedtowatchin2018,”Forbes, citing CB Insights, October 18, 2017, https://www.forbes.com/sites/paularmstrongtech/2017/10/18/5-emerging-proptech-startups-you-need-to-watch-in-2018/#74a98cdc4494, accessed January 24, 2019.
33. Griffith,“Thehotpropertythat’snextontech’sagenda:realestate.”
34. Armstrong,“5EmergingPropTechstartupsyouneedtowatchin2018.”
35. Verman,“WhatisPropTechandhowisitchangingrealestateinvestment?”
36. 2019 Deloitte Commercial Real Estate Outlook.
37. Jim Eckenrode and Sam Friedman, Fintech by the numbers: Incumbents, startups, investors adapt to maturing ecosystem, Deloitte Center for FinancialServices,November16,2017,https://www2.deloitte.com/content/dam/Deloitte/tr/Documents/financial-services/dcfs-fintech-by-the-numbers.pdf.
2019 Real Estate M&A Outlook | Building momentum
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