September  2009 VOL. 2

U.S. REITs Regroup
Balance sheets strengthened with equity and debt offerings

Earlier this year, things were looking pretty grim for the U.S. REIT sector. Without exception, REITs saw stock values drop significantly, pushing their debt-to-equity ratios out of whack and weakening their balance sheets. With the credit markets frozen and REITs unable to refinance much of their mortgage debt, it seemed many REITs were on the verge of financial disaster.

Nine months later, the outlook for U.S. REITs is far more positive, primarily because they’ve tapped equity and debt markets. By recapitalizing, REITs have strengthened their balance sheets and positioned themselves for growth. 

“They needed to fix their balance sheets so they could survive and thrive,” says Keven Lindemann, director of the real estate group at SNL Financial in Charlottesville, Va.

Big REITs go first

So far this year, U.S. REITs have raised more money through common stock offerings than in the past nine full years, according to SNL Financial. As of mid-August, U.S. REITs had raised more than $15.9 billion in equity offerings. Moreover, as the credit markets have loosened, several REITs also have issued unsecured debt. In the first eight months of 2009, U.S. REITs have issued more than $1.3 billion of unsecured debt. 

Although a few REITs issued equity in early 2009—Digital Realty Trust and Health Care REIT, for example—the REIT re-equitization wave kicked off in earnest in the middle of March and has continued at a fairly steady clip. Since March, there have been 48 deals raising approximately $15.285 billion of new equity. 

Among the first REITs to issue equity were bellweather companies including Simon Property Trust, AMB Properties Trust and Ventas Inc. “There was a bit of trepidation to see how the market would receive them,” Lindemann notes, adding that, in a number of cases, the REIT stocks outperformed the broader market during the period directly after their offerings. “You would have expected the opposite to happen.”

Indianapolis-based Simon, for example, raised $543 million in March, and when the market responded positively to the offering, the REIT issued more equity in May, raising $1.1 billion. In addition to Simon, three other REITs have revisited the equity markets twice this year: LaSalle Hotel Properties, Hospitality Properties Trust and HCP Inc.

Thus far, the office sector has raised the most capital, more than $2.8 billion. Manhattan office owner SL Green Realty raised $407 million to bolster its balance sheet, as did northern New Jersey-focused Mack-Cali, which raised $288 million. Other raises include: Brandywine Realty Trust ($254 million), Kilroy Realty Corp. ($196 million) and Highwoods Properties Inc. ($151 million).

Similarly, retail and industrial REIT sectors have both raised a fair amount of equity. Multifamily companies, with access to agency debt through Fannie Mae, have been much less active issuers of equity.

Expensive, but necessary 

Earlier in 2009, many REIT CFOs discounted the idea of issuing new equity, pointing to the dilutive effect it would have on existing shareholders. But as the credit crunch continued, attitudes changed. 

“There was a point where people were saying that the big REITs didn’t need to do these kinds of offerings, but when they saw the big guys going into the market, it suddenly made them realize that waiting for the market to turn was like waiting for a lottery ticket to win,” says Yaacov Gross, partner in Morrison & Foerster’s New York office and head of the firm’s real estate securities practice group.

It’s true that new equity is expensive, but it’s just part of surviving the liquidity crunch, according to Sheila McGrath, an analyst with Keefe, Bruyette & Woods. The average discount from the prior day’s close was 8.5 percent, with the retail sector having some of the largest discounts from the prior day’s close, with CBL & Associates priced down 20.6 percent from the prior day’s close and Kite Realty Group down 20 percent.

“From a purely mathematical standpoint, in many if not most cases, the stock was being issued at a level that was dilutive and probably implied a valuation on the properties that was well below what the properties were worth,” Lindemann says. “But, as one REIT CFO said, ‘You raise equity when you can, not when you need to.’” 

Lindemann says a number of dedicated, large institutional investors really pushed and made a commitment that they were going to back these companies, especially the large, liquid REITs. “That commitment encouraged these companies to issue stock even at fairly depressed pricing levels,” he explains. 

Opening the unsecured debt door

Experts note that the “window” for issuing equity is open, and the interest in equity has created opportunities on the unsecured debt side as well. 

“It’s not just the large bellweather REITs that were able to issue equity, some of the smaller REITs were able to tap the equity market as well,” Lindemann says, noting that the interest in these equity offerings spreads well beyond the large dedicated REIT investors to smaller funds and non-dedicated funds. 

“These equity offerings, shored up the balance sheets and took REITs out of potentially distressed situations, and fixed-income investors are responding,” Lindemann says. “I don't think you would see the level of bond issuance without those equity offerings.”

Simon also was among the first REITs to issue unsecured debt. In fact, Simon has had three issuances since March. The first offering in March, which generated $650 million, had a coupon rate of 10.35 percent. The REIT’s most recent offering just last month raised $500 million and had a coupon rate of 6.75 percent. 

Other REITs have been able to raise smaller amounts at even more favorable coupon rates. Federal Realty Investment Trust, for example, raised $150 million through an unsecured debt offering with a coupon rate of 5.95 percent. 

More offerings to come

McGrath expects REITs to continue to tap the equity market for at least two more years, initially for deleveraging and eventually for acquisitions. With sector average debt/EBITDA levels still north of 7x, there clearly is more equity to be raised to bring leverage ratios lower, she contends. She forecasts $50 billion to $100 billion will be raised over the next several years. 

The most recent round of equity and unsecured debt issuances has simply allowed REITs to get back to business. “After months of holding their breath, REITs can start breathing again,” Gross says.