Is the REIT Sector’s Edge at Risk?
Listed REITs have been at the forefront of the recovery in multifamily and commercial property investment. For more than a year, access to public equity and debt markets has allowed the best-positioned REITs to retire or refinance pending maturities and to re-engage the market through strategic acquisitions of properties.
Buoyed by improvements in market capitalization and stock market investors’ appetite for new and secondary offerings, REITs have outpaced many other aspirant buyers who have had to wait for improvements in secured credit availability, growing their market share in kind.
Apart from direct acquisitions of properties, REITs have also undertaken many of the largest portfolio and corporate acquisitions of the recovery. According to Real Capital’s most recent analysis, REITs’ privileged position in 2010 allowed them to emerge as net acquirers of property for the first time in five years.
The pipeline of planned and prospective REIT initial public offerings suggests that investors remain sanguine in their assessments of the sector’s acquisition outlook. Actual IPO activity in 2011 may fall short of projections if mergers and acquisitions remove emerging firms from play.
The Pick of the Litter
In the depths of the financial crisis, stock markets’ low estimation of the commercial property sector and the potential for a crisis around REITs’ debt schedules precluded significant capital raising outside of the distress arena.
In 2009, listed REITs represented just 8 percent of all significant property acquisitions by dollar volume, down from 15 percent in 2005. Surging forward in the afterglow of their renewed liaisons with investors, listed REIT market share increased to 18 percent in 2010, its highest level in recent memory and second only to private buyers’ 30 percent of the market. No longer a niche investment channel, non-listed REITs also increased their market share over the past year, from 6 percent in 2009 to 9 percent in 2010.
In the apartment sector, listed REIT activity was weighted to mid- and high-rise properties, where they captured 20 percent of all sales, and student housing, where niche REITs accounted for almost a third of activity. REITs captured a relatively smaller share of properties in distress and a larger share of high-priced properties. Apart from their 18 percent share of all office activity, REITs have also been significant drivers of medical office volume, where they captured 36 percent of sales.
The unusually large share of medical office sales reflects the exceptional vigor of health care REITs over the past few quarters. These REITs have been among the most active in accessing the unsecured debt market, where their current cost advantages are readily apparent. According to data sourced from the National Association of Real Estate Investment Trusts, REITs issued more than $17 billion in unsecured debt in 2010, 70 percent more than in 2009 and more than three times the issuance in 2009. Remarkably, the average coupon on this debt in Q4 ’10 was just 4.1 percent, 150 basis points below the 5.6 percent average for secured mortgage financing during the same period.
While investors appear ready to increase their exposure to property markets, through both new and existing channels, REITs will face stiffer competition for high-quality assets as the recovery progresses.
Mortgage financing has improved considerably since mid-year 2010, drawing a wider variety of buyers to market. More intense bidding for properties in major markets has fueled increases in prices that often belie relatively weaker fundamentals, requiring that REITs look further afield and take on additional risks in making opportunistic acquisitions or in considering viable options for development.
REITs may be able to maintain their cost advantage, however, as rising long-dated interest rates will have a disproportionate impact on investors seeking secured financed to undertake acquisitions.
Sam Chandan, Ph.D., is global chief economist of Real Capital Analytics and an adjunct professor at the Wharton School.