Griffin Capital Essential Asset REITs I and II Merger Examined
August 23, 2019 | James Sprow | Blue Vault
On April 30, 2019, Griffin Capital Essential Asset REIT II, Inc. (“GCEAR II”) merged with Griffin Capital Essential Asset REIT, Inc. (“GCEAR”).
The press release issued on May 1, 2019, explains the sponsor’s views regarding the merger.
“The merger creates a $4.7 billion, self-managed REIT, which will generate significant benefits for shareholders, including substantial cost savings, increased operating efficiencies, and immediate accretion to earnings and cash flow. Operating as GCEAR II, the combined company brings together two highly-complementary, similarly-constructed portfolios with analogous investment mandates, significantly increasing the size, scale, and diversification of the new entity.
“We appreciate the confidence of our shareholders who voted overwhelmingly in favor of this merger, which will deliver immediate and significant value,” said Michael J. Escalante, CEO and President of GCEAR II. “GCEAR II is well-positioned for the future and our experienced management team is committed to intelligent growth of the portfolio and the continued generation of superior income and overall risk-adjusted returns for our shareholders.”
As previously announced on December 14, 2018, GCEAR completed a self-administration transaction which provided immediate benefits to GCEAR shareholders, including a considerable reduction in the operating expenses of GCEAR; these benefits will extend to the combined company, effective today. On March 13 and April 15, 2019, GCEAR II and GCEAR shareholders respectively voted to approve the transaction; approximately 90 percent of the shares voted were in favor of the merger.”
Although the merger had Griffin Capital Essential Asset REIT merging into Griffin Capital Essential Asset REIT II, with the latter named as the surviving entity, shortly after the merge was consummated, the REIT changed its name to drop the “II” and is now Griffin Capital Essential Asset REIT.
The Internalization Transaction
The internalization transaction which occurred on December 14, 2018 essentially moved employees from Griffin Capital Company to the REIT, meaning that the asset management fees and performance fees previously paid to Griffin Capital Company under GCEAR’s third-party advisory structure would be eliminated. In the transaction, GCEAR acquired Griffin Capital Real Estate Company (“GRECO”). According to the Proxy statement concerning the merger proposal, ”The Combined Company will no longer bear the costs of the various fees and expense reimbursements previously paid to the former external advisors of GCEAR and GCEAR II and their affiliates; however, the Combined Company’s expenses will include the compensation and benefits of the Combined Company’s officers, employees and consultants, as well as overhead previously paid by the former external advisors of GCEAR and GCEAR II and their affiliates.” In connection with the self-administration transaction, 37 employees of Griffin Capital Company became GCEAR employees through GRECO. The employees include professionals in the following key areas: acquisitions, asset management, investor relations, legal, compliance, financial reporting, and accounting.
In a presentation by GCEAR on Second Quarter 2019 earnings results and a portfolio update on August 15, the REIT highlighted a significant decline in general and administrative expenses as a result of becoming self-administered which eliminated all third-party advisory fees, including asset management fees and performance fees. The quarterly filing by GCEAR for Q2 2019 reports general and administrative expenses for the three months ended June 30, 2019, of $5.656 million, zero asset management fees to affiliates and zero property management fees to affiliates. For the three months ended June 30, 2018, for example, the general and administrative expenses were $1.489 million the asset management fees to affiliates were $5.947 million, and the property management fees to affiliates were $2.234 million. Combining the three expense categories for both Q2 2019 and Q2 2018, the totals declined from $9.670 million to $5.656 million or 42%. This decline supports management’s statement regarding one of the benefits of internalization.
The Combined REIT’s Portfolio and Performance
The combined REIT had a total market capitalization as of June 30, 2019 of $4.7 billion, which includes outstanding debt balances net of deferred financing costs and premiums/discounts, plus preferred equity, plus total outstanding shares multiplied by the NAV. The acquisition value of the combined REITs totaled $4.2 billion, with 101 properties comprising 124 buildings and 27.2 million square feet.
At the date of the merger, the REIT’s NAV per share was estimated at $9.56. As of June 30, 2019, the NAV per share was $9.54. The decrease was primarily attributed to exposure to the impact of interest rate changes through the REIT’s borrowing activities. Volatility in interest rates in May and June impacted the values of the interest rate swaps the REIT uses to hedge a portion of its variable rate borrowings.
The performance data of the various common stock share classes are presented on a quarterly basis for Q2 2019 and since inception. The inception dates differ for the different share classes, which makes the “Since Inception” returns comparisons less meaningful. The sales loads will have differing impacts on the returns since inception calculations. Over time the sales loads will tend to have less impact on annualized returns for longer holding periods, as can be observed in the differences in returns with and without sales loads for Class T shares (2.11%) and Class E shares (1.40%). Total returns are a function of both the distributions for the different share classes and the changes in NAVs.
The Current Offering
The REIT is currently offering on a continuous basis up to $2.2 billion of shares of its common stock, consisting of $2.0 billion of share in its primary offering and $0.2 billion of shares pursuant to its distribution reinvestment program (“DRP”). The public offering has four classes of common shares: Class T, Class S, Class D and Class I. The share classes have different selling commissions, dealer manager fees and ongoing distribution fees and eligibility requirements. The board of directors extended the termination date of the follow-on offering to September 20, 2020.
On any business day, the share sales are made based on the day’s applicable NAV per share. On each business day, the NAV per share for each class of common stock is (1) posted on the REIT’s website, www.gcear.com, (2) made available on a toll-free, automated telephone line, 1-888-926-2688, and (3) made available on www.nasdaq.com.
The REIT’s change to a continuous offering at share prices determined by daily NAVs increases the transparency of shareholder values and mirrors the trend among other nontraded REIT continuous offerings.
With the recent decline in interest rates, the fair value of the REIT’s fixed-rate borrowings increase and the value of its interest rate swap contracts decrease. If interest rates rise, there would be a positive impact on the fair value of fixed rate borrowings and interest rate swaps, the opposite net effect on NAVs.
