Can REITs Sustain their Spending (and Borrowing) Sprees?
By: Adam Weinstein
If one man’s meat is another man’s poison, then bad mortgage assets are filet mignon to real estate investment trusts. And there is a feast afoot. Nowhere has the economic upswing of the past few months been more dramatic than in the realm of REITs. A confluence of factors â€” government incentives, a housing rebound, available liquidity â€” has led many hedge funds and private investors to form new REITs to acquire commercial and residential mortgage-backed assets at deep discounts. But skeptics say the dizzying heights seen by some REITs, along with overleveraging, inflated values and a worsening commercial mortgage downturn, will lead to a nose dive. In the meantime, business is booming. Since spring of this year, mall owner CBL & Associates Properties, for example, has seen a 400 percent increase to $8 per share. That’s well above the already-impressive average REIT gain over the same period, which stands at 71 percent. It’s no surprise that as property values near a recession-induced bottom and inventories of unsold property swell, investors sense they can take advantage of immense deals on marked-down loan assets. But such ambitious acquisitions require lots of capital â€” more, even, than is
immediately available to many of the private equity firms and hedge funds that are jumping into the REIT business. The solution: Going public, and using proceeds from an initial public offering to gain leverage and drive acquisitions. Invesco Mortgage Capital Inc., Starwood Property Trust Inc., and PennyMac Mortgage Investment Trust â€” all recently formed REITs â€” launched IPOs in recent weeks to cover their investment strategies. In all, REITs have raised roughly $1.2 billion in IPOs in the last two months, according to the industry data site Linex Legal. The driving factor behind the REIT explosion is that increase in liquidity, said Brad Case, vice president of research for the National Association of Real Estate Investment Trusts, a trade advocacy group. “Investors are responding to the resolution of the liquidity crisis by publicly traded REITs,” he said. All well and good â€” except many of the firms are in danger of overextending themselves. CBL’s leverage ratio stood around 80%, even after raising $382 billion in an IPO in June, according to the Wall Street Journal. First Industrial Realty Trust and Developers Diversified Realty have exhibited similar leverage problems. Likewise, PennyMac’s plans could go awry, after its IPO raised less than half of the $750 million it was aiming for. Those pressures are compounded by the REITs’ obligations to their investors, who by rule must receive 90% of company earnings as dividends. Add to that the chorus of skeptical voices about the commercial mortgage market’s direction â€” just this week, the Federal Reserve’s Beige Book report predicted declining commercial values for the next few quarters â€” and the REITs may find themselves walking a very thin line between success and insolvency. “After their rapid ascents, any hiccups in the economic-recovery story driving investors’ risk appetite could exact a heavy price on the shares,” the Journal wrote.
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