- Feb 11, 2015
Being a public company has its advantages, even with the onerous reporting requirements it entails. Just ask the multifamily real estate investment trusts. Being publicly traded gives these REITs ready access to all forms of secured and unsecured financing, in addition to equity financing. Their executives say that this provides them a financing advantage, which is particularly useful in today’s low interest rate-induced highly competitive environment.
Jeffrey A. Friedman, chairman and CEO of Associated Estates Realty Corp., a suburban Cleveland-based REIT, explains, “If there is a property or a piece of land we want to buy, we can just write a check for it. We don’t have to wait for someone to come out and underwrite it or provide a loan commitment. Buyers that do need financing take longer to be able to commit. So sellers who are looking for certainty of closing would deal with many of us publicly traded REITs, because they know that we can deliver faster than a local or regional buyer.”
Preference for development
Given that intense competition for acquisitions means lower returns, these REITs tend to favor new development over acquisitions for their higher returns. For Associated Estates, development makes it easier to build in very specific locations and add certain features, particularly technology-related, in a way that is difficult to do by buying existing properties. The REIT, which has a significant presence in the Midwest, is engaged in development in Dallas; Bethesda, MD; Los Angeles and San Francisco.
Atlanta-based Post Properties, which has a Sunbelt focus, also prefers to go the development route in today’s environment. Dave Stockert, Post Properties president and CEO, says, “Yields are low across the board. So it is a very active market for acquisitions, and pricing is being bid up. One of the reasons we prefer to develop is because we can develop at a lower cost than what we can buy something at. When you buy something, you’re just basically paying market price.”
After owning a property for 10 years or more, Post Properties tends to sell it and reinvest the money in other developments, a strategy that led it to exit the New York City market in 2014 with the sale of two Manhattan properties to a condominium converter.
Houston-based Camden Property Trust, whose properties are located primarily across the U.S. “smile”—from the Mid-Atlantic and Florida to the Sunbelt and down to Southern California—is also geared more to developments than to acquisitions today. Ric Campo, Camden CEO, notes, “There are outsize deals to be had in development, which generally tend to be 100 to 200 basis points wide of what you can buy a property for, from a cap rate perspective.”
The company, which looks for pro-business markets with a high presence of educated millennials, strategically buys and sells properties with an eye to keeping the portfolio age to an average of 10 to 12 years. This way, Camden keeps its portfolio up-to-date with current trends and consumer needs.
While these REITs tend to favor development, Home Properties, a Rochester, N.Y.-based REIT whose area of operation is up and down the East Coast, is taking a different approach by exiting development activity.
According to Ed Pettinella, Home Properties president and CEO, “The good news for us is that there are 10 public companies, but the other nine are predominantly “A” quality and are heavily in development. We don’t do development, and we buy “C” and “B” quality properties. So we’re an enigma in the sector. When we are out competing for properties, we really don’t run into our peer group.”
Playing the financing advantage
Home Properties was recently awarded a “BBB”-equivalent credit rating from Fitch Ratings, Moody’s and Standard & Poors, Pettinella says, and is looking to tap the public debt market in 2015 for the first time ever. This means it won’t have to rely so much on secured GSE financing and can shift to unsecured public debt that will be fixed at today’s low rates for up to a 10-year period.
Pettinella says, “It is an unusual positive period of time where there are many capital sources available for our industry. We haven’t had to go to CMBS or life companies to borrow. The doors are still wide open to our lowest cost and better-term capital sources.”
Another way these REITs are tapping the public markets is through access to an “At The Market” or ATM facility that allows them to issue equity shares and raise financing as (and when) they have a need for it.
Camden’s Campo is cautious about the ready access to financing though, noting, “You have to be discreet with the issuance of equity because equity is the highest cost component in your capital structure. So it is always about balancing your weighted average cost-of-capital with what you are investing that capital in to make sure you are not going overboard on costly funds.”
Even in the case of debt financing, Campo notes, “People get seduced by incredibly low interest rates. They forget that leverage increases risk and therefore the rate of return on your equity [had] better go up pretty dramatically if you are going to risk higher leverage in your capital structure.”
Low interest rates aren’t forever
Of course, interest rates can’t remain at today’s historic levels forever, and the Federal Reserve has started signaling that they are likely to start moving to a tighter money policy in 2015. Campo is also watching to see how things will play out as the Fed “takes the economy off life support.” That’s why the REIT is “staying very liquid.”
Stockert is more optimistic about any fallout from the Fed’s actions. He says, “It depends on how high short-term rates go and how rapidly they raise them, but if it’s fairly gradual, it may not be that disruptive. The thing that really drives real estate prices is what’s going on with longer-term rates. And the 10-year Treasury is very low. Growth is slow all around the world so even if the Fed raises short-term interest rates, it’s not clear that interest rates are going to go spiking up.”
Pettinella anticipates that given the low levels of inflation today, the Fed will not have to take dramatic action.
There are other challenges
Today’s low inflation also presents a challenge since wage growth has been slow as a result, giving REITs less leeway to raise rents, according to Associated Estates’ Friedman.
Campo worries that some industry participants might go overboard in taking advantage of the easy availability of financing, forgetting about the cyclical nature of the industry. Even though Camden’s home base of Texas is likely to be slowed down by the recent oil price bust, Campo expects that the state is better prepared considering that it has a more diversified economy now than in the past.
And Stockert, concerned about the robust supply on the multifamily front, is keeping an eye on the supply situation. However, he is more concerned about the unknowns out there. He notes, “Two months ago, no one was really talking about $50 oil. So it is going to be the thing that isn’t on everybody’s radar screen that you are going to be surprised by. And it could be some kind of global event. Maybe there is a credit issue with one of the European countries, or just anything. We know we’re taking development risk so we just want to finance our balance sheet with lots of equity and low leverage.”