The Recapitalization of the Commercial Real Estate Sector Has Begun
- New, accretive refinancings announced daily
- The spreads can be massive
- Improved cost of capital opportunities are even available to small and micro-cap players
- REIT share prices don’t reflect this new strengthening, and some may be cheaper than previously perceived
Back in March, in a herculean effort to create liquidity, the Federal Reserve pledged a multi-trillion dollar expansion of its balance sheet through the purchase of a broad swath of securities. In September Chair Jay Powell declared that interest rates would stay at or near zero through 2023. This largesse has finally come to REITs. Here are just a few recent examples of the action.
Earlier this month, Health Trust of America (HTA) announced issuance of $800MM 2.00% ten-year notes. They will use the proceeds to redeem $300MM 3.7% notes due 2023, reducing annual interest expense by $5.1MM (increasing income by $0.0233/share). On 9/22 they increased their dividend. On 9/23 they reinstated a $300MM share repurchase program which will further increase FFO/share.
On 9/18 Healthcare Realty Trust (HR) announced the issuance of $300MM 2.05% Senior Unsecured Notes due 2031. Simultaneously, they announced the redemption of $250MM 3.75% Senior Notes due 2023. While the 1.7% lower coupon of the new notes will save them ~$4.2MM/annum in interest expense ($0.031/share), the $21.5MM early extinguishment charge HR will take in the 4th quarter makes the maneuver look a little dubious.
Even bolder, On 09/07, Interxion (Digital Realty’s recently acquired European unit) announced a strategic land acquisition in Madrid. On 09/09, they acquired Altus IT to establish a business presence in Croatia. On 09/14, they simultaneously announced the redemption of €300MM 4.75% Guaranteed Notes due 2023 and that they would pay for the redemption with the issuance of €1.05B super cheap, long-dated debt. Not done yet, and this is where it gets really interesting, on 09/15 they announced the redemption of Digital’s 5.875% Series G Preferred Stock.
On August 20 UHM Properties (UMH), a small-cap REIT in the manufactured housing sub-sector, announced the completion of a $106MM 10 year 2.62% Fannie Mae credit facility. They will use the low-cost proceeds to redeem a $95MM 8% Series B preferred stock and save more than $5 million annually ($0.124/share) in financing costs. Additionally, UMH has a $374MM high coupon preferred series that become callable from 7/2022 to 1/2023 which portends more significant savings to come.
So where is the opportunity in all this cheap capital?
Where’s the risk?
If we break down the DLR example we can demonstrate both risk and reward. The new, nearly zero cost Euro debt is being deployed for accretive acquisitions and to retire high cost capital. The opportunity is the resulting pass-through earnings growth in Digital’s common shares. The risk was the 3.25% haircut the DLR preferred G shareholders sustained when the redemption was announced on September 15th.
The same scenario is true in the UMH example with the redemption of a high coupon preferred, paid for with the low-cost Fannie Mae debt. If UMH can close out their two remaining preferred series for similar cost spreads, three years from now their FFO/share will be running 50% higher than today.
In both cases, consider the operationally improved common shares and avoid premium-priced preferreds.
It is a great time to be studying the full universe of REIT equities.
With an abundant availability of lower-cost credit and capital, the REIT sector is reshaping itself.
Callable, high coupon REIT preferreds are going to be redeemed and you don’t want to own them if they are trading over par. Callable, high coupon REIT preferreds trading at a discount to par (and there are $billions) might present a route to high yield and capital appreciation.
Common shares of REITs that can significantly restructure their capital stack, like DLR and UMH, might be a real opportunity.
Do your homework.
Please contact us to discuss the opportunities we see in today’s economy.
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