Embracing a $21 Billion Real Estate Deal

Yesterday, American Realty Capital Properties announced it was acquiring Cole Real Estate Investments in a transaction valued at $11.2 billion. As a result of the deal, the merger would create a REIT that will have an enterprise value of more than $21.5 billion -- which will be 64% greater than its nearest competitor.

The two companies each operated in the net-lease space -- where Realty Income Corporation and National Retail Properties are major players. These net-lease REITs own free-standing buildings that are then leased out to corporate tenants (like CVS or McDonalds), who pay for all of the property expenses in addition to the rent. Often, these are long-term leases that can be highly lucrative for the companies that own the properties.

As it relates to the strategic reasons for the acquisition, the companies highlighted that this transaction will increase both the competitiveness and scale of the companies. It will also lead to greater diversification of the lease portfolio (ARCP had single-tenant properties, while Cole had multi-tenant ones), and it could also result in inclusion in the S&P 500 and a greater number of institutional investors.

The first point is an essential one because the net-lease REIT industry has seen major consolidation in recent months, and competitors like Realty Income have been actively acquiring companies, as well. The new American Realty Capital Properties will now have 3,732 properties with more than 600 tenants, and it will be 99% occupied with an average lease of 11 years.

Considering that Realty Income has 3,681 properties, it remains the closest competitor in terms of scale -- and, although National Retail Properties is roughly half the size, with 1,838 properties, it boasts a better lease term of 12 years. At the outset of the merger, American Realty Capital Properties and Cole Real Estate Investments will create an organization that is poised to be the industry leader, and that will only grow with time as the merger is completed, allowing it to be more competitive by growth through new relationships while ,at the same time, it invest in old ones.

Financial rationale
While the strategic rationale behind the deal is compelling -- the financial side of things is where things get even more interesting. As a result of the acquisition, American Realty Capital Properties announced it was upping its adjusted fund from operations (AFFO) 25%, from $0.91-$0.95 per share, to $1.13-$1.19. In addition, it would increase its dividend by a little more than 6%, to $1.00 per share.

However, the truly interesting thing in this deal is the reduced leverage that the new company will be faced with. Thanks to increased cash flow and earnings (the strategic side of things), the company will see its net debt to EBITDA decline from 9.1 times, to 7.7 times, by the end of 2014. That means that the company will likely have less need for debt financing, and its cost of serving that debt will go down. In addition, the company highlights that "ARCP's investment grade rating allows for significantly lower cost of financing," which directly corresponds to the company's bottom line.

Net-lease REITs have been particularly affected by the rising interest rate environment and, as you can see in the chart below, they have been truly affected as rates have risen since May:

O Chart

Source: YCharts

If the company is, in turn, able to become less reliant on this debt financing, and perhaps even get better terms on that financing, it could lead to greater compounded returns from the strategic benefits outlined above that will go straight to shareholders. Although the net-lease REIT industry is a competitive one, this deal could be one that is for the best for all parties involved.

Beyond this deal
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The article Embracing a $21 Billion Real Estate Deal originally appeared on Fool.com.

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