More Buybacks Loom, with More Risk for U.S. REITs

By Reinor Bazarewski, Director, U.S. REITs, Fitch Ratings: Share buybacks are becoming more appealing for U.S. equity REITs, though they come with additional risks over time for bondholders.

Reinor Bazarewski

Share buybacks are becoming more appealing for U.S. equity REITs, though they come with additional risks over time for bondholders.

REIT stocks outperformed broader indices during this past quarter. However, a net asset value discount remains and presents share repurchases as an intriguing use of capital. Also worth noting is that improved balance sheets since the recession are making potential share repurchases easier for REITs to rationalize. REIT leverage is declining toward levels last seen before the crisis and may tempt issuers to pursue buybacks and challenge their financial discipline in maintaining strong credit metrics and ample liquidity. Despite the short-term appeal of share repurchases as an intriguing use of capital, it is a trend that Fitch Ratings views negatively.

Share repurchases may be a plus for REIT net asset values in the short-term, but over time the resultant increase in leverage could impair credit quality. It is important to note that current REIT leverage is now above levels seen at the end of 2006, just before share buybacks spiked sharply during the last credit cycle.

Where these share buybacks may take place most frequently over time is likely datacenter and multi-family REITs.

Leverage for datacenter REITs is the lowest sector-wide. In light of this, Digital Realty Trust and DuPont Fabros Technology are beginning to heed market feedback by recently implementing share repurchase plans. While leverage among multi-family REITs is higher (albeit still moderate), they are continuing to trade at a meaningful net-asset value discount thanks to decelerating same-store net operating income growth and elevated new supply in several markets. It is for these reasons that Fitch expects future buybacks among datacenter and multi-family REITs to be the most plausible in the coming months.

That said, the REIT structure restricts share buybacks given their limited ability to retain cash flows. Fitch expects these structural considerations to limit large stock repurchases over the longer term. Optimistically, the severe economic downturn and subsequent en masse deleveraging may also have permanently changed the mindsets of REIT managements to maintain greater fiscal responsibility.