What are SPACs: Special Purpose Acquisition Company Impact on CRE
Special Purpose Acquisition Companies and their Impact on CRE
What is a SPAC? Special purpose acquisition companies have made headlines in recent years as an alternative way for companies to go public. In short, SPACs are shell companies that raise money through an initial public offering (IPO) with the sole purpose of acquiring an existing company. During the first years of the COVID-19 pandemic, the creation of these special-purpose companies grew at a remarkable pace. According to the Harvard Business Review, 59 SPACs were created in 2019, garnering $13 billion in capital. But in 2020, that number grew to almost 250 SPACs, with investments totaling $96 billion.
While SPACs aren’t a new endeavor (they’ve been around since the early ‘90s), their popularity during the pandemic was driven by a few factors, including these advantages of SPACs:
Increased Investment Opportunities: Institutional investors and high-net-worth individuals brought large amounts of capital to CRE developers and operators. Since SPACs aren’t limited by traditional investment criteria, these shell companies were able to invest in a broader range of real estate assets.
Greater Access to Capital: SPACs provided an alternative way for companies in CRE to access capital. Typically relying on bank loans to fund projects, investors were now able to access a broad range of funds without giving up control or equity to lenders. It is important to note, however, that investors in a SPAC will typically gain shares of the acquired company or asset.
So, How Do SPACs Work?
In a traditionally structured company, an IPO occurs after business operations have been set, allowing investors to buy into the now-public (but already operating) company. Their potential earnings, share prices, and more can be assessed based on the company’s prior performance, and the company can earn useable capital by purchasing shares.
A SPAC, on the other hand, raises capital from SPAC investments before any offering or business operational standards have been determined. The IPO is an opportunity for investors to join in on an investment venture that has yet to be decided. Generally, once formed, the SPAC members have up to two years to determine their target company for acquisition.
SPACs operate through a series of steps that allow them to form a group of investors and acquire a target company.
Step 1: A group of investors creates the company by raising money through an initial public offering. The SPAC is then listed on the stock exchange like any other public company. The difference is that a SPAC’s offering is an opportunity; investors buy in for a chance to be part of an acquisition and will later have an opportunity to get their money out if they choose to do so.
Step 2: Once formed, the SPAC has a limited time (typically two years) to find a company to acquire. During this time, the SPAC’s management team searches for a target company that meets certain criteria (such as company size or desired industry).
Step 3: Once the SPAC identifies an acquisition, negotiations occur to work out a deal. This deal is typically subject to shareholder approval.
Step 4: If the shareholders approve the acquisition, the SPAC uses the money from its IPO phase to purchase the target company. That company then immediately becomes a publicly traded company under the umbrella of the SPAC, and the SPAC effectively disappears.
Step 5: The original investors in the SPAC usually receive shares in the newly acquired company, with the option to sell them on the stock exchange if they don’t want them.
How Are SPACs Used in Commercial Real Estate?
SPACs can be used to acquire CRE assets in a few different ways:
Direct Acquisition: A SPAC can use the funds raised in its IPO to acquire a commercial real estate asset or portfolio.
Merger: What is a SPAC merger? A SPAC can merge with a real estate operating company that owns CRE assets. This allows the SPAC to acquire assets indirectly via the merger. In this scenario, the target company would become a subsidiary, and the SPAC would become a publicly traded company.
Real Estate Investment Trust (REIT): If the target company is already a REIT, the SPAC can acquire it through a merger or an acquisition. This allows the SPAC to use its funds to create a new REIT and use the IPO proceeds to purchase new CRE assets.
What Was the SPAC Crash in 2021?
Thanks to their rapid rise in popularity during the beginning of the COVID-19 pandemic, SPACs quickly became subject to a slew of problems that led to a major crash in 2021 and 2022. There were several factors at play in the crash, drawing attention to the risks of investing in SPACs:
Regulatory Scrutiny
One of the biggest benefits of acquiring CRE or any other type of asset through a SPAC is the ability to sidestep much of the scrutiny involved in a traditional IPO to go public. Regulatory agencies are aware of this, and with the drastic increase in the number of SPACs being formed, many determined it was time to take a closer look at these “blank check companies.” The Securities and Exchange Commission (SEC) issued guidance in April of 2021 that raised concerns about accounting in SPACs and made it more difficult for them to attract investors.
Market Saturation
With so many SPACs entering the market at once, demand increased for target companies, and investor interest waned. Many SPACs struggled (or even failed) to find suitable acquisition targets and were forced to extend their deadlines or liquidate their funds.
Poor Performance
After completing mergers or acquisitions, many SPACs and their target companies did not perform as expected. This led to a loss of investor confidence in the model and a steep decline in stock prices.
Interest Rate Hikes
Increased interest rates imposed by the Federal Reserve led to a further decline in investor interest in riskier investments like SPACs. The combination of poor performance and high interest rates was a recipe for losing cash, and savvy investors knew this.
What’s the Future of SPACs?
While the market for special purpose acquisition companies has become more regulated, the model remains a proven concept, especially in emerging high-growth industries. Even after the decline in 2021 and 2022, it’s important to remember the past successes of the concept. Thankfully, the regulations and guidelines being put in place will likely increase investor confidence once again, leading to a stabilized outcome for the acquisition model.
How Can Dottid Help?
Regardless of what model is used for acquisition, asset sales will continue to happen, and it’s important to have your asset data easily on-hand and organized when the time comes to make a deal. With Dottid, you own your data and it’s not shared with anyone else - which means you maintain the edge in negotiations.