REITs: Risk Perception and Prospects

A three-axial analysis of some of the most prominent REIT names yields some interesting results. The chart below is a 3D scatter plot of Z spreads of REITs bonds (for this analysis bonds maturing in 2015/2016 were selected) based on today's bond market levels (Z spread is the CDS equivalent spread for a specific bond; as most names are trading sub 1,000 it is fair to say that convexity is not much of an issue), versus the company's leverage level, and juxtaposed to today's stock market capitalization of the underlying company.



The chart above excludes outliers ProLogis (PLD), whose 5.625% of 2016 had a 1,577 bps Z-spread on 19.7x leverage, and Developers Diversified (DDR), whose 5.5% of 2015 bonds had a 2,145 Z-spread on 10x leverage. PLD indicatively has $1.7 billion market cap while DDR is at $267 million.

If one assumes efficient markets, the greater the leverage (higher on the chart) and the greater the risk perceived from the credit side (further right on the chart), the worse the prospects for equity recovery. Yet as the chart above shows there are some pretty dramatic aberrations.

I leave the chart for your consideration without making explicit conclusions, although will note that either credit or equity markets are mispricing risk substantially at many of these companies.

Comments

[TheSnail:]

Really enjoy reading your stuff, dude.

A must daily read.

Mar 18 03:48 PM

[robert99:]

If I were planning on buying anything else (I'm 70% long, which is enough for me for now), I'd be researching the hell out of these companies to find the diamond in the rough. If nothing else, information like this gives the small investor a good springboard to use for further research. Once again, Tyler comes through with solid information.

Mar 18 05:49 PM

[mr. mann:]

i like the bubbles with letters on them. they are pretty.

Mar 18 08:22 PM

[Mad Hedge F...:]

I am more convinced than ever that real estate has another 25% to fall, and best case, it is dead money for another five to ten years. The New York Times produced some insightful data on inflation adjusted home prices for the last 120 years, which baselines at a $100,000 for a single family home in 1890. Few people realize how superheated the recent real estate bubble really got. Past bubbles very consistently peaked at $125,000 in 1896, 1979, and 1989. This last one peaked at $205,000 in 2005, almost double the previous record highs. And while we have dropped 34% since then, to $135,000, we haven’t even fallen to the past all time highs yet. If you look at historical lows, my call for a further 25% slump looks positively bullish. We saw lows consistently around $66,000 in 1920, 1932, and 1942. Postwar lows came in at $105,000 in 1976, 1983, and 1996. These figures suggest the best case low is down a further 28%, and the worst case is down another 51%. I think I’ll go find something else to trade.

Mar 18 08:49 PM

[Chris B:]

Interesting. I've been studying HCP, looking for the catch...

Current ratio: 2.58 check!
Leverage: Acceptable for an REIT
Rapidly declining debt levels... check!
Does declining debt explain declining cash flow?... yes, check!
Stable revenues...fairly stable, check!
Customers:
- Hospitals... stable, economically insensitive
- Senior housing... stable, economically insensitive
- Medical office buildings... stable, economically insensitive
Positive earnings... check!
Excessive executive compensation?... no, check!
Valuation:
-Selling @ book value
-P/E of 10, earnings growth expected
-expected yield ~ 9%, fairly safe
Increasing dividends?... check!

The bottom line question that a potential investor has to answer is this: Will healthcare property leases generate less income in the future as a result of this recession? Or are hospitals and senior housing somewhat immune?

Mar 19 10:10 AM

[Emerald:]

Historically, apaprtment REIT's are safer investments due to the short term nature of their leases, i.e. one year, and that pension funds like multifamily as an investment. Equty Residential and AvalonBay (in the above chart) are currently oversold and have significant upside potential over a three year horizon. Both will continue to pay decent dividend yields even if forced to cut them by 25% and issue stock in exchange. AS to Mad Hedge's comments, I agree these are not for short term trading but are candidiates for a longer term hold.

Mar 19 10:37 AM

[jimmy46:]

on inflation adjusted home prices for the last 120 years, which baselines at a $100,000 for a single family home in 1890. """"""""

100 YEARS AGO YOU COULDN'T GET A 30 FIXED RATE MORTGAGE ON A HOME.

YOU ALSO DIDN'T HAVE A DOZEN DIFFERENT STATE & FEDERAL TAX BENNIES SUPPORTING HOME OWNERSHIP.

Mar 19 02:42 PM

[FreeMkts:]

Does anyone on these boards understand capital structure? Right now you can buy debt on many REITs at 40% to 60% discounts to par. Add up the current market value of all debt plus equity and the valuations are so far below book it is amazing. DDR is a great example because they are one of the few companies with decent debt strucuture info in their presentations. Even valuing their mortgage bonds at par currently, their total book value is $8.9 billion versus less than $5.5 billion market value of all stock and debt. Plenty of room there for the Mad Bear Hedge Fund Manager's dismal outlook. Forget the equity and evaporating dividends. "Settle" for 12% - 30% YTMs in REIT debt and preferred stocks.

I don't see how the stocks can dramatically recover before these anomolies in the debt markets are corrected.

Mar 30 02:42 PM