The real estate industry has become a dirty word over the past nine months or so. However, real estate investment trusts (REITs) are standing their ground despite the mortgage market's liquidity fears, with new companies looking to enter the space, notably on the agency MBS side.
This month, Point Asset Management Co., managed by Federated Investment Counseling, and North Sound Mortgage Investments Corp, managed by BNP Paribas, both filed registration statements with the Securities and Exchange Commission for IPOs worth $250 million and $350 million in common stock, respectively. Deutsche Bank Securities, Credit Suisse and Morgan Stanley are the underwriters on North Sound's IPO.
Meanwhile, American Capital Agency Corp., managed by American Capital Agency Management, filed with the SEC for a proposed IPO a month ago. Citigroup and Merrill Lynch will act as joint book runners on the proposed offering.
These companies will specialize in investing in MBS guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. In a release last month, American Capital said that it would invest "exclusively" in single-family RMBS and CMOs.
Indeed, tough times can present opportunities to buy assets at good prices in both the residential and commercial mortgage market. However, financing these operations will be difficult, according to analysts. "2008 will be about the ability of REITs to navigate a challenging capital markets environment more than anything else," said Steven Marks, managing director and REIT group head at Fitch Ratings. "Utilizing short-term lending facilities, which typically mortgage REITs have used to finance the acquisition of assets, is much more difficult since short-term lending facilities likely expose buyers to margin calls." He added that given the disappearance of the CDO market, which has been a popular long-term financing tool, extended financing for mortgage REITs has vanished.
However, common equity can still be a viable financing option for REITs if there is a defined accretive use of proceeds, Marks said.
In addition, some REITs may issue common equity to repay debt, but those companies will likely be the exception and not the rule, according to Marks. "Unsecured debt and preferred stock are trading at wider spreads relative to recent years, and issuers will access these markets because they have to, not because they want to," he said.
One REIT issuing common equity to pay down debt is General Growth Properties (GGP), which announced a public offering last week of approximately 22.8 million shares of its common stock at $36 a share, or approximately $821.9 million in net proceeds.
GGP said it will use the proceeds to repay its revolving credit facility and other debt, as well as for other corporate purposes.
However, Marks said that companies are more likely to buy back stock because of the limited acquisition opportunities and because they want to increase funds from operations per share.
Calm in the Storm?
But REITs, particularly equity REITs, remain a relatively stable industry, according to analysts. While the REITs with large maturities coming due are a source of concern, there are not many of them, according to Chris Wimmer, vice president and senior analyst in the real estate finance team at Moody's Investors Service.
Multifamily REIT AvalonBay Communities had its ratings revised by Moody's on March 20 to stable from positive, because of the size of the company's project pipeline amid soft economic conditions and the company's heightened use of its line of credit.
However, the secured debt market for large investment-grade REITs is still very liquid, said Philip Kibel, senior vice president in Moody's real estate finance team. Despite wide spreads and a lack of demand in the senior unsecured market, these companies have solid liquidity because they took advantage of the very frothy market conditions over the last few years. This will provide sufficient capital cushion for at least the next 12 to 18 months, Kibel said. He also cited their high occupancy rates and solid net operating income growth despite the expected job losses and slowdown in retail sales that would affect office building and retail properties.
Multifamily properties are also seeing opportunity in the GSEs on the funding side.
Since financing has dried up in many of these REIT sectors, GSEs have been very active in the last 12 months or so in providing financing to multifamily companies, said Wimmer. For instance, according to Moody's, Equity Residential Properties Trust, the largest multifamily REIT, took care of its entire year's financing with a GSE earlier this month. The REIT closed a $500 million secured loan originated by Wachovia Multifamily Capital for repurchase by Freddie Mac.
Bottomed Out?
While it is too early to say whether the REIT market has hit the bottom, "we are not at the lowest point we have been at, which was a 26% loss," said Brad Case, vice president, research and industry information at NAREIT. For one, the FTSE NAREIT Equity REITs index is up 3.23% year to date as of March 21. This index outpaced all other major market benchmarks, including the Nasdaq composite, which was down 14.86%; the Russell 2000, down 10.81%; the Dow Jones, down 6.81%; and the S&P 500, down 9.01%. "I feel confident that at least we are closer to the bottom than the top," Case said.
In general, REITs have been outperforming other institutional owners of real estate assets for some time now. In the late 1980s, with the downturn in the commercial real estate market, REITs were not as badly damaged as some other investors. When people were ready to invest again, a lot of the other methods had been discredited - for instance, limited partnerships, Case said.
As a result, REITs during the early and mid-1990s went through a tremendous boom. "A downturn has a way of clearing out the weaker actors in the industry, and it is very possible that REITs will be in a stronger position [when we come out of this downturn] because of the fact that the non-REIT actors in the industry who loaded up on so much debt will suffer that much more pain as a result," Case said.
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