Duke Realty: Another REIT on the Mass Dilution Bandwagon

Yet another troubled REIT Duke Realty (DRE) has jumped on the Kimco (KIM), ProLogis (PLD), etc. Merrill Lynch/BofA orchestrated mass dilution bandwagon, and investors, some confused about what the hell is going on, others like Cohen & Steers (CNS), are more than happy to join the great pump and dump even as all REITs face imminent debt maturities, declining lease rates, tenant bankruptcies, and generate less and less cash flows to satisfy their respective debt loads, let alone dividend payments.

As for use of proceeds: no surprise there - pay off amounts outstanding under the company's $1.3 billion JP Morgan (JPM) and Bank Of America (BAC) arranged credit facility (yes, observant reader, the very same companies who are underwriting this travesty). This is exactly the kind of "deal" that Zero Hedge reported about when Kimco raised equity, however without the same day upgrade by Merrill analysts. The Stardust line on Sakwa's upgrade to Buy is 4 days. We take the under.

Here are the facts: Duke has priced 65.4 million shares, and will likely also place the 9.8 million share green shoe, once Merrill analyst Stephen Sakwa goes unrestricted and changes his opinion on the company from neutral to buy, although that condition is neither sufficient nor necessary (we jest, everyone knows that Steve Sakwa will evaluate the company on it's own standalone merits). The 75 million new total shares will be a 50% dilution of the total existing shareholder base of 148 million. But, as Merrill has likely pitched to both the management team and to investors: it has worked so far, no reason why it should stop. This is the same reason bulls give to explain the market run up. Nobody needs to be bothered with such trivia as fundamentals, cash flow, FFO, EPS, and dilution. The game of greater fool is on right now like it has never been, and if big funds like abovementioned Cohen & Steers manage to get a quick bump up in their March P&L, so much the better.

To simplify what is going on here, follow the buck:

Underwriting Banks -> New Equity Investors -> Company -> Underwriting Banks Who Are Also On The Hook For The Credit Facility: the buck stops here, compliments of the fresh money.

Clinically simple and elegant. Ignore that GGP has filed for bankruptcy. Rinse and repeat.

And, yes, it will work, until the potato gets too hot... just like all other doomed REITs, just like the market.

Ironically, now that pretty much all the REITs will receive new equity money, the whole thesis that the strong will acquire the weak flies out of the window, and instead of excess capacity getting removed from the market (for a good case study of massive excess capacity, please see the vivid example of Ainsworth Lumber, Norbord and Louisiana Pacific in the OSB market), it will just stay there indefinitely, destroying any pricing power the REIT "giants" such as BXP and SPG could hope to generate. Compliments of Merrill Lynch, irrational exhuberance and a 110x trailing P/E.

For perspectives on when the CRE bubble will finally crash and burn, read here, here and here.

Comments

[jasonjim:]

So Tyler, Mr. Smart Guy, what would your solution have been to resolve the serious debt problems faced by DRE? Instead of bashing the company, maybe a little credit is due the company for getting itself out of a financial mess in a very tight credit economy. When business improves in the future they can always buy back the surplus shares to improve the EPS. As you point out this is serious share dilution, but the share price has been mired at a very depressed level for a long time now, so the value is already diluted by over 200% compared to its previous highs because of debt problems. The new share issuance assures the market that the debt problem is no longer an issue. The price for this is 50% dilution, which is better than the present 200% dilution. The shares are now worth $20 IMO rather than the $8 or $9 range or less that we have seen for months.

Apr 17 08:54 AM

[REITBull:]

Yeah I have to agree with jasonjim. I ran my own dilution scenarios using 10K's about a month ago for a number of REITs including DRE. My conclusion was that the market had already priced in an excessive amount of dilution to these stocks. With each successful offering, the need for more stock issuance begins to decrease, driving the share price to more normal levels.

Disclosure: Long URE

Apr 17 09:21 AM

[REITBull:]

I should add that anyone who did not see the dilution coming in these stocks has not done their homework. So I don't agree with lashing out at the companys that are issuing more common stock.

Apr 17 09:24 AM

[Carlos Lam:]

On Apr 17 08:54 AM jasonjim wrote:
> So Tyler, Mr. Smart Guy, what would your solution have been to resolve
> the serious debt problems faced by DRE?

The "solution" was not to get so overleveraged in the first place. The Duke strategists apparently never anticipated that taking on too much debt could lead to problems. They were not alone in thinking this way, but there are other good companies that didn't become overburdened with debt. Had Duke never become overleveraged, share dilution would not be an issue at this point.

Apr 17 10:37 AM

[Mad Hedge F...:]

But wait! There's more! The big listed REIT’s are grasping for a life raft, a life preserver, or a flotation device of any description they can get their hands on. Even Pamela Anderson will do! They have used this month’s ferocious short covering rally to engage in some prodigious equity fund raising, nearly $4 billion in total. Only companies drowning in debt would be raising equity at these subterranean prices. Prologis (PLD) lifted $1.15 billion, followed by Chimera (CIM) $810 million, Kimco Realty (KIM) $747 million, Vornado (VNO) $645 million, and AMB Property (AM $576 million. I guess management isn’t sleeping too well at night. Existing shareholders are being diluted up to the gills. But half an asset is better than nothing. Many bought commercial properties with cap rates as low as 3% at the top of the market, betting that rents inflated by an endless retail boom would drag them up to 7-8% over time. The opposite happened, and some properties now have negative yields in extreme cases, with massive debt, and irate tenants pounding on the table demanding lower lease rates. Bankers are taking their pound of flesh, rolling over short term debt with only the most draconian terms, merrily widening spreads, adding covenants, and chopping loans to value along the way. I wonder if this orgy of recapitalization is simply an effort to bail water out of a sinking craft, or a battening down of the hatches for the tidal wave that is about to hit them. Women and children first!

Apr 24 04:59 PM