REIT Rout Seen Curtailing Deals as Rising Rates Cut Share Sales
The Bloomberg REIT Index has dropped 11 percent from an almost six-year high in May as the yield on 10-year Treasury notes surged amid speculation the Federal Reserve would reduce bond purchases, which have kept borrowing costs low. The decline was three times the slump in the Standard & Poor’s 500 Index.
Just five U.S. property REITs have sold shares this month, down from 14 in May and eight in April, according to data compiled by Bloomberg, and Tom Barrack’s house-rental trust Colony American Homes Inc. postponed an initial public offering in early June. Because federal tax laws require REITs to distribute most of their earnings to investors through dividends, the companies rely on stock and debt sales to raise money for real estate purchases.
“For most property types, I think we’ve hit the pause button,” said Jim Sullivan, a managing director at Green Street Advisors Inc., a Newport Beach, California-based real estate research firm. “We’re going to see a period here where REIT executives are very careful in what they do with respect to new acquisitions.”
Purchases completed by U.S. REITs through June 27 were double the $17.6 billion in the year-earlier period, according to data compiled by Bloomberg. This year’s total was boosted by Lehman Brothers Holdings Inc.’s sale of apartment owner Archstone Inc. to Equity Residential and AvalonBay Communities Inc. for $16 billion, including $9.5 billion in assumed debt. The deal was completed in February.
REITs also have $17.5 billion in pending acquisitions announced this year, led by Mid-America Apartment Communities Inc.’s planned purchase of Colonial Properties Trust for about $2.2 billion in stock.
A decline in deals may limit a rebound in commercial-property values. A Green Street index of prices, compiled from estimates of REIT holdings, had recovered all of its losses from the real estate collapse and as of May was 4 percent higher than its previous peak in August 2007.
With bond yields low, REITs have been an attractive investment alternative with their higher, steady returns -- an advantage disappearing with rising interest rates. Since REITs rely on the equity and debt markets to raise money for acquisitions, they are vulnerable to jumps in interest rates. They have access to capital through credit agreements that they can use for short-term funding obligations, said Keven Lindemann, real estate group director at SNL Financial in Charlottesville, Virginia.
“The near-term impact of the market turmoil is that we won’t see any significant equity issuance until the market stabilizes,” he said in a telephone interview.
REITs will be reluctant to take on debt as a replacement for stock sales because they won’t want to boost leverage and make themselves even less attractive to investors, said Craig Guttenplan, an analyst at CreditSights Inc. in London. Tapping into existing property would be a better source of new capital for the companies, he said.
“They’re not going to leverage themselves to the hilt,” Guttenplan said. “They’re going to look at asset sales.”
Single-tenant and health-care REITs have been among the most active issuers of equity this year. The sectors have been attractive to investors because of the stable cash flows offered by the long duration of their tenants’ leases, making them comparable to bonds.
Since the slide in REIT shares began, the two groups have been hit harder than other types of landlords. The Bloomberg single-tenant index has dropped 19 percent since May 21, and the health-care REIT index has slumped 16 percent.
One of the biggest REIT buyouts completed this year was in the single-tenant industry, according to data compiled by Bloomberg. Escondido, California-based Realty Income Corp. (O), the largest landlord in the sector, purchased American Realty Capital Trust Inc. for about $2 billion excluding debt, in a deal completed in January.
Health Care REIT Inc. (HCN), the third-largest REIT in its sector by market value, had the largest property-trust equity offering this year, according to data compiled by Bloomberg. In May, it sold $1.5 billion in shares, excluding underwriter allotments, at $73.50 each to pay debt and for general purposes, including acquisitions. The Toledo, Ohio-based company also last month completed a $697 million investment in a joint venture to own a majority stake in 47 Canadian housing properties for the elderly.
Such purchases may become less common now, said Paul Adornato, an analyst at BMO Capital Markets in New York.
“The REITs are probably just going to sit on the sidelines for the dust to settle before they do the math and make the decision if an acquisition makes sense,” he said in a telephone interview. “It’ll take some time for the dust to settle to see where REITs stand relative to the broader market and what the implications are for the cost of capital.”
Health-care and single-tenant REITs historically have grown through acquisitions to boost dividends, said Sam Lieber, chief executive officer of Purchase, New York-based Alpine Woods Capital Investors LLC, which manages the Alpine Funds. The return from their acquisitions is the spread between the cost of raising capital and the yield from property purchases. Share-price declines and rising interest rates tend to increase the cost of capital, reducing returns.
“They don’t offer a lot of growth,” Lieber said.
Single-tenant and health-care REITs have less flexibility to raise rents because of their lease lengths, which are making other REIT types more appealing to investors. Apartment, industrial and regional-mall landlords are attractive because they have a greater ability to raise rents and grow internally, said Paul Curbo, a portfolio manager in Dallas with Invesco Ltd. (IVZ), which had $752 billion under management as of May.
“Internal growth starts to matter more,” he said in a telephone interview. “We still favor those kinds of companies.”
Even the more desirable REIT types are cutting back on equity sales. This week, UDR Inc. (UDR), a Highlands Ranch, Colorado-based apartment owner, reduced its 2013 forecast for equity offerings to zero from a previous estimate of as much as $125 million. UDR, whose shares are trading at a discount to what its properties are worth, won’t sell any shares until its stock gets back to at least the company’s net asset value, according to Chief Financial Officer Thomas Herzog.
“At current price levels we would not issue shares, but that does not preclude us in the future if our share price were higher,” he said.
REIT shares have gained 5 percent in the past three days as 10-year Treasury yields fell to the lowest in a week. Federal Reserve officials said yesterday that investors may have overreacted to prospects for a reduction in the central bank’s bond-buying program.
Demand from investors across the commercial real estate industry remains strong, said Raymond Torto, global chief economist at CBRE Group Inc., the world’s biggest commercial-property services firm.
“If someone said to you two months ago, ‘I will sell you the building at this price,’ he’ll stick to that price today,” Torto said yesterday at a conference in New York. “The buyer may have higher borrowing costs. That will slow things down, but I don’t see the seller changing his price. If that guy can’t get the money, there’s 10 guys behind him with the cash.”
Rising interest rates probably would be the result of an improving economy, which would in turn benefit REIT shares, according to Sheila McGrath and Nathan Crossett of Evercore Partners in New York.
“We expect a bounce-back for REIT stocks and believe the recent selloff should provide investors an attractive entry point,” the analysts wrote in a June 23 report. “If rates are going up given an improving economic outlook and a bounce-back from unsustainably low interest rates, like it appears, we believe this short-term correction should be viewed as an opportunity.”
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