Fitch: Following DELL Buyout, Are REIT LBOs Next?
NEW YORK -- February 11, 2013
The recently announced leveraged buyout (LBO) of Dell Inc. (rated 'BB+' with
Rating Watch Negative by Fitch) has caused speculation as to what other
sectors might see an increase in LBO activity, especially considering the
extremely low interest rate environment. Given their secured debt-conducive
real assets, equity REITs are frequently mentioned as LBO candidates, but we
believe that is unlikely due to the still-constrained CMBS market and the
traditional covenants in unsecured bonds.
LBOs have largely been absent from the REIT landscape since a flurry of deals
in 2006 and 2007 when REITs such as CarrAmerica Realty Corporation, Equity
Office Properties Trust (EOP), Innkeepers USA Trust, and Archstone-Smith Trust
were taken private. Each transaction was essentially predicated on the
placement of additional secured debt on the portfolio and in the case of EOP
specifically, CMBS debt ($7 billion of CMBS and mezzanine debt remained after
significant asset dispositions). It is improbable that today's CMBS market
could or would finance a similar volume to a single borrower as 2012 issuances
were only $48 billion. We expect origination volumes to grow in 2013 to
upwards of $60 billion; however, this would still represent only 25% of 2007
levels. This understates the true magnitude of the EOP transaction on the CMBS
market as affiliates of The Blackstone LP (rated 'A+' with a Stable Rating
Outlook by Fitch) sold a significant portion of the portfolio to other parties
that ultimately utilized CMBS. Our perspective on REIT LBO risk may change as
the depth and breadth of the CMBS market improves.
Additionally, bondholders are protected by the traditional REIT maintenance
covenants that limit total secured debt to less than 40% of undepreciated
assets and total debt to less than 60% of undepreciated assets. As a result,
acquirers would be forced to either limit the amount of debt incurred or
negotiate with bondholders for a consent payment and subsequent tender of the
bonds. The former likely diminishes the return profile to a point where a deal
may not occur and the latter places bondholders in a pivotal and potentially
valuable "blocking" position. In the case of EOP, unsecured bondholders
actively negotiated with Blackstone over the amount of the consent payments
before tendering the majority of the bonds.
In the unlikely event of an LBO, corporate securities such as preferred stock
are unprotected by consent-inducing covenants and at risk for being deeply
subordinated to substantial property-level debt at the private company. The
increased inclusion of change-of-control and coupon step-up provisions in REIT
preferred stock documentation only partially mitigate this risk for investors.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit
market commentary page. The original article, which may include hyperlinks to
companies and current ratings, can be accessed at www.fitchratings.com. All
opinions expressed are those of Fitch Ratings.
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Britton Costa, +1 212 908-0524
Associate Director, REITS
Kellie Geressy-Nilsen, +1-212-908-9123
One State Street Plaza
New York, NY 10004
Sandro Scenga, +1-212-908-0278
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