So far this year, global merger and acquisition (M&A) activity in the real estate sector has reached new heights. In fact, Dealogic reports that as of the third quarter of 2017, the volume of real estate M&A, globally, was the second highest on record. While a variety of factors can account for this trend, one in particular is the changing retail sector.

Real estate companies with operations in the retail sector are trading at notable discounts, thereby enhancing their appeal as targets for M&A activity.

Across the United States and to a more limited extent, Canada,  there have been widespread closures of retail stores and shopping malls, which some have coined the “retail apocalypse”. While disadvantageous for retailers, these mass closures appear to have promoted M&A activity in the real estate sector by driving valuations down. In particular, real estate investment trusts (REITs) that own and operate retail stores and shopping malls and similar other real estate companies are currently trading at discounts to their net asset values (NAVs). Such discounts, prompted in part by fears of a sinking retail sector, appear to have encouraged the buying and selling of these affected companies.

It is worth noting that despite decreasing valuations and cautioning by some investors, fears of the so-called retail apocalypse appear to be overstated. For example, for some time, e-commerce retailers have been increasingly opening storefronts in attempts to establish a brick and mortar presence for their existing online businesses or for new businesses altogether. The addition of these new players to the physical retail space would seem to suggest a strengthening of the “offline” retail market. Nevertheless, as retail REITs and similar other retail real estate companies continue to trade at discounts to NAV, this renewed interest in offline retail should presumably supplement the investment appeal of retail real estate targets.

Online retailers require industrial properties for the operation of their businesses, which may promote investment in associated real estate companies like industrial REITs. 

Despite the prospective resurgence of brick and mortar retail, as discussed above, the e-commerce retail market continues to flourish. In order to succeed, these online retailers largely depend on warehouses of significant scale and sophisticated logistics systems. After all, absent storefronts with readily available merchandise, the efficient and timely delivery of products are critical features of the online retail model. This reliance on industrial properties, alongside the sizeable (and likely enduring) online retail market, may encourage investment in industrial REITs, brokerages specializing in industrial properties and the like.

Overall, it appears that the struggles and changes afflicting one sector appear to be another’s antidote for growth. As retail real estate companies continue to trade at discounts to NAV and as e-commerce continues to prosper and by extension rely on industrial properties then, controlling for other variables, we are likely to continue to see booming real estate M&A.

The author would like to thank Samantha Sarkozi, Articling Student, for her assistance in preparing this legal update.

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