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GE Capital and Trustreet: Two Trends in One

Two trends converged Monday with the announcement of the proposed $3 billion acquisition of Trustreet Properties, a net lease REIT that specializes in restaurant properties, by the Franchise Finance division of GE Capital Solutions.

The deal underscores the increasing cachet of restaurants within the net lease world and Trustreet becomes the latest publicly held REIT to be taken over by a private equity entity.

Restaurants represented 10 percent of the $42 billion in net lease properties that were available for purchase as of mid-May, according to the net lease broker Boulder Group. By comparison, retail properties accounted for 31 percent.

But the restaurant business—and, by extension, restaurant-related real estate—is growing far more quickly than overall retail and provides more deal opportunity. Restaurants accounted for 17.4 percent of expansion activity in the retail sector this year, with only discount retailers outpacing them at 19 percent, according to research from brokerage firm Colliers International. Daily restaurant sales in the U.S. currently stand at $1.4 billion, says the National Restaurant Association.

That is why GE Capital, one of the largest net lease players in the market, has been focusing on expanding its restaurant business for more than a year, says Joseph French, senior vice president of institutional retail sales with Sperry Van Ness, a national real estate investment brokerage firm.

The company’s Franchise Finance group is based in Scottsdale, Ariz., and has an $11 billion asset portfolio in the U.S. and Canada. The group services approximately 6,000 customers and holds 20,000 locations belonging to the restaurant, hospitality, branded beverage, power sports and automotive after-market industries. It has built a portfolio through sale-leaseback deals, such as one in May where it bought 34 Burger King restaurants from franchisee Simmonds Restaurant Management for $50 million.

The acquisition of Orlando-based Trustreet will enable the Franchise Finance group to bolster its presence on the East Coast, said the spokesman for GE Capital Solutions.

“Restaurant real estate is a business they were late to get into and the deal with Trustreet is a great way for them to expand,” says French. “Restaurants are a huge business – more and more franchisees are opening up Burger Kings, and Dunkin’ Donuts and Wendy’s. Americans are eating out more and cooking less and GE being the smart operators that they are and having plenty of money to loan, saw that this is a great business to expand.”

In addition, private equity firms have been buying out restaurant chains and franchises and then pushing for sale/leasebacks on the real estate. There have been about 30 buyouts since the beginning of 2005.

Since its formation in February of 2005, Trustreet has grown as a REIT, but the fact that 65 percent of its capital base was made up of debt and preferred equity caused concern on Wall Street. Analysts believed that Trustreet could not engage in further growth without selling some of its properties or selling additional shares of its stock – something the company was reluctant to do. In July, the research and rating site Morningstar downgraded the REIT’s fair value estimate from $17 a share to $15 because of re-capitalization concerns. The large amount of variable rate debt that Trustreet carried has caused it stock to under-perform, analysts say, in spite of an otherwise solid performance.

The buyout deal will put an end to those concerns with a fresh capital infusion. As part of the deal, GE Capital Solutions will assume or refinance Trustreet’s outstanding debt.

Trustreet was formed as a result of the merger between CNL Restaurant Properties, Inc., U.S. Restaurant Properties, Inc. and 18 CNL income funds. In its current form, the company owns approximately 2,015 restaurant assets in 49 states. Its tenants include Wendy’s, Burger King, Applebee’s, Jack in the Box, KFC, Pizza Hut and IHOP, among others. Its portfolio is split between operators of fast-food chains and full service establishments.

Trustreet offers investor yields of 7.78 percent, higher than any other REIT in the net lease sector, according to Cantor Fitzgerald research.

The deal represents the closest yet that retail REITS have come to becoming part of the privatization wave that has engulfed the REIT universe. Since 2004, private firms have spent nearly $60 billion taking REITs private. However, none of those deals was for a retail REIT.

Trustreet may be the largest owner of restaurant buildings in the country, says Jerome J. Herman, principal of Cleveland based J.J. Herman & Associates.

“Trustreet is the gorilla in that industry – not only do they do 1031 exchanges, they own thousands of freestanding restaurant properties around the country,” he says. “And, GE is very, very active in the restaurant business – both in lending money to restaurant operators and to people who want to own restaurant buildings and land and equipment.”

According to the terms of the deal, GE Capital will pay $17.05 per share for Trustreet’s outstanding stock, representing a 36.3 percent premium on the company’s closing price of $12.51 on Oct. 27. Trustreet and GE Capital Solutions plan to combine the REIT’s 1031 exchange trading platform with GE Capital’s franchise finance business.

Now some analysts are raising Trustreet’s price target to $18 per share. “Although another bid is not expected, we would not be surprised if an additional interested party surfaced,” writes Cantor Fitzgerald analyst Philip Martin. “[It’s] not necessarily out of the question, especially given the size, reach and diversification of the Trustreet portfolio, along with its relationships and proven operating performance and franchise.”

The acquisition is scheduled to close in the first quarter of 2007. After the merger was announced, Trustreet’s stock jumped from $12.46 a share to $16.95 a share by the end of the day Monday, an increase of 36 percent

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