Fitch: Looking for Liquidity, REITs Find Choices, Conundrums

Staying liquid is job one for many equity REITs these days, and the lack of a CMBS or unsecured market makes that a formidable task. Most of the choices bring both answers and potential pitfalls at a time of unusual urgency, contends Fitch Ratings in a recent report. “In essence, the clock is ticking for REITs to maintain adequate liquidity,” the report stated. Of all potential sources of capital, bank lines of credit will be the leading source of liquidity for REITs through 2010, Fitch predicts. By the end of last year, revolving credit facilities represented 64.4 percent of the source of REIT liquidity. Revolving facilities even gained in importance during the fourth quarter, increasing their share of total REIT liquidity by 4.8 percent. One trend that Fitch says it watch carefully, however, is the use of bank credit to pay off maturing debt. Fitch’s preferred scenario is that a REIT’s revolving credit lines are greater than both the company’s maturing debt obligations and its recurring capital expenditures for the next two years. Fitch also speculates that the large pool of unencumbered assets owned by many REITs may offer alternatives. Investors like commercial banks, life insurance companies and pension funds may view wide bond spreads as an incentive to create new debt sources. One option may be longer-term collateralized instruments like secured term loans, a route that Developers Diversified Realty Corp. and iStar Financial Inc. and their lenders have taken recently. “The likelihood of other REITs following suit continues to rise with the passage of time,” Fitch states. Fitch casts a favorable eye on the strategy of buying back debt as a discount, a step that has become increasingly popular. In December, for example, ProLogis paid $217 million for bonds with a principal value of $310 million scheduled to mature in November 2010. This strategy can reduce interest and leverage costs and be a good investment. But the ratings agency is concerned about any REITs that buy back bonds that are maturing later than 2010 because of the lower discount. That could create trouble if it limits a REIT’s ability to meet bond obligations that are coming up this year and next, the report explains. For multi-family REITs, loans securitized by Fannie Mae and Freddie Mac provide secured debt capital. Fitch cites Colonial Properties Trust and Camden Property Trust as examples of multi-family REITs that funded loans with the government-sponsored entities at attractive terms that included loan-to-value ratios around 60 to 70 percent and coupons in the 6 percent to 7 percent range. But the ratings agency warns that those transactions also create something of a Catch-22. Fannie and Freddie debt provides REITs with much-needed liquidity, but also weakens the position of existing bondholders. Yet passing on debt provided by Fannie and Freddie poses its own conundrum: maintaining a good-size pool of unencumbered assets at the cost of declining liquidity.