Mizuho’s Haendel St. Juste Talks REIT Leverage, Rising Rates and Niche Asset Classes
Last week’s REITweek investor conference at the New York Hilton Midtown brought together professionals from real estate investment trusts large and small to get their arms around the latest in capital-market developments for publicly traded landlords. Fresh off a whirlwind week of meetings, REIT analyst and Mizuho Securities USA Managing Director Haendel St. Juste debriefed Commercial Observer on where the sector is headed.
Commercial Observer: You always hear that REITs underperform when interest rates rise. Does that have to be true if the fundamentals are strong?
Haendel St. Juste: That’s one of the key debates in REITs. REITs tend to underperform in the initial stages of a rising rate environment, but we actually have some data that show that there is a period of time afterward that REITs have outperformed…anywhere from 300 to over a thousand basis points in the subsequent six months. [Today,] the reasons why rates are rising certainly tend to reflect an improving economy, which includes improved space demand and credit availability. Those are clearly good for real estate landlords.
How would you apply that framework to today’s situation?
Here we are very late in the fundamental cycle. Growth is slowing. You look at a number of the core real estate asset classes, and there certainly are softening fundamentals. Retail has been the poster child, and there certainly is a sense that it could be finding a floor here. I’m not ready to call a recovery in retail yet, but I think we do have some tailwinds, [such as] improving consumer confidence and discretionary spending. There have been fewer store closures this year. But certainly that’s a sector to keep an eye on.
Have you seen any changes in how REITs are using leverage this year?
Today, looking at debt-to-EBITDA [earnings before taxes, depreciation and amortization] is just about 5.5 times, which in my view is fairly healthy. Certainly, we have seen REITs taking advantage of more accommodation debt costs over the last five years to lower their overall costs and to extend their debt maturities. And a number of them have learned their lesson from the prior recession. It’s been a focus of theirs to maintain good liquidity, not only from a perspective of not wanting to be forced into selling off assets at an inopportune time to pay down debt but also to maintain a liquid, opportunistic balance sheet. In late cycles, there tend to be opportunities that pop up. REITs want to be in a position to take advantage—not to be taken advantage of.
Analysts have pointed out a shift toward REITs accessing term loans as opposed to unsecured debt. How do REITs choose what flavors of financing to pursue?
When you ask CFOs, they say they like to have the full arsenal at their disposal, be it secured, unsecured, lines of credit or mortgages. Having an investment-grade balance sheet gives you more options. And [term loans] certainly play into a mindset that better-quality balance sheet, lower leverage puts you in a better position to be opportunistic. The idea is that having the best balance sheet gives you the best access to opportunities.
We’re coming up on the busiest leasing season for residential landlords. How important are the summer months for multifamily REITs?
In the second and third quarter, [multifamily] REITs will do about 60 or 65 percent of their annual leasing volume. That’s when people tend to move most. Landlords have adjusted their maturation schedule to drive more of the lease expiration during that peak leasing, so you’re getting more people looking at your portfolio.
In May, we spoke with the CEO of Americold, who felt that the REIT structure was perfect for cold storage. You see the same with cell towers, self-storage and data centers. Why are there symbioses between REITs and niche sectors like that?
What you’re seeing is the emergence of REITs in the non-core real estate assets classes in the last few years. Different companies and different industries have looked to the REIT model as a way to become more efficient and to avoid corporate taxes. The REIT structure has provided them that opportunity. But the dynamic behind a number of these sectors is the growth. Think about the REIT sector [at large] that is facing decelerating fundamentals and soft growth. [REITs in general are expecting] growth of about 4 percent this year—not that exciting. But the data centers and cell towers are expecting double-digit earnings growth. So that’s certainly drawn investor attention. There’s a search for high-conviction ideas, given where we are late-cycle. Increasingly, when you look at REITs that have outperformed versus a benchmark, it has been because they have invested more capital in these noncore real estate asset classes. That’s where the outperformance has been.
The sector is at the intersection of a lot of industries.
It is. That’s one of the things that make my life interesting.