REIT Debt Is Outperforming other Market Segments

The market for real estate investment trust unsecured debt has grown tremendously since the 1970s, when it was "nonexistent," and REIT debt is now among the top performers, according to Thierry Perrein, director, global high-grade credit research, Credit Suisse First Boston.

Moderating a panel session on the state of the REIT debt market at the National Association of Real Estate Investment Trusts' Institutional Investor Forum here, Mr. Perrein noted that the performance of REIT debt has been aided by the limits on the debt that REITs can place and by "maintenance covenants."

Lisa Sarajian, managing director, structured finance, Standard & Poor's, said that the rating agency has been working on a rating transition study on the REIT sector which shows that in the BBB-rated spectrum, REIT debt has outperformed both corporate debt and commercial mortgage-backed securities. The 11-year period for which the study was done reflects a period of growth, consolidation and the recent downturn, she said.

John Kriz, managing director, real estate finance, Moody's Investors Service, wondered how many of the REITs that have recently gone public through initial public offerings will be around in five years.

"A number of folks have claimed victory for getting wet by getting caught in the rain," he said, noting that REIT performance in recent years has been aided by a confluence of low interest rates, access to capital and a recession that "was not all that big," except in the case of the lodging sector.

The REIT structure has also helped and going to the marketplace to ask for money "provides adult supervision," as he sees it. And REITs have been able to access international capital, especially money from Australians who have been looking to the United States in a bid to deploy the "embarrassment of riches" from superannuation funds.

Tara Innes, managing director, Fitch Ratings, said that REITs have been issuing debt in a large way since the mid-90s and Fitch now views the sector as maturing. Fitch has also undertaken a study on this sector, has been "favorably impressed" and expects to "reflect that in more upgrades." The Fitch study also leads Ms. Innes to believe that covenants continue to lower the default probability associated with REIT debt.

Stephen Sterrett, chief financial officer, Simon Property Group, noted that after withstanding the "significant upheaval" of the last few years, with the recession followed by the impact of 9/11, REITs present a better credit prospect.

In one example of a covenant preventing a REIT from doing what it wanted to do, Mr. Sterrett said that when SPG was interested in acquiring Rouse Properties "on an all-cash basis," they were prevented from doing that. Ultimately, Rouse was acquired by General Growth Properties.

About the size of REIT debt transactions, Keith Olsen, director, BlackRock, said that they "as a general rule do like a bigger deal," considering anything below $250 million to be small. Mr. Olsen believes that the use of joint-venture structures "complicates a situation." Considering that joint ventures introduce more risk, he expects a "differential" that he hasn't seen yet.

Mr. Sterrett noted that Simon uses the joint-venture structure either to conduct a transaction that would not go through otherwise (for instance, when a founding family or landowner wants to get in on a deal) and sometimes to manage risk.

Weston Andress, CFO & CIO, Colonial Properties Trust, said that they are in the process of using a joint venture to sell some assets, while maintaining some assets that Colonial likes.

Mr. Kriz noted that from the perspective that a partner brings something to the table, a joint venture might be a good idea. It also provides strategic flexibility. There is no "permanent cash flow," however. Also, while the benefits are realized upfront, the costs are annuitized. He believes that joint ventures are one option for management teams who face pressure to "move top lines."

Ms. Sarajian sees joint ventures as "very effective risk mitigants, but not effective risk transfer," since most REITs are using the same management team and it is "pretty tough to segregate" the business.

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