REITs: Cheap Debt, Easy Earnings

Recently we have heard people talking about REITs raising equity in order to pay down bank debt (underwritten of course by the same banks being paid back). One of the other use of proceeds (directly or indirectly) was the purchase of the companies bonds at below market prices - which boosts earnings.

Why? Well, here's Equity One (EQY) (from yesterday's earnings release) with the explanation:

Fourth, during the quarter we repurchased $30.5 million of our own debt at an average price of $0.70 on the dollar. The total cost was $21.4 million for a yield to maturity of 11.3% and a gain of $8.7 million. Since quarter end we have repurchased an additional $6.5 million of our 2016 and 2017 debt at an average price of $0.63 on the dollar. This will result in a $2.3 million gain in our second quarter numbers. Give all of our investment opportunities, we saw this one as the best on a risk adjusted basis as it was accretive to cash flow, net asset value and at the same time lowered our leverage.

This was followed up by a tender offer Thursday evening by Prologis (PLD) tendering for its 5.5% '12s and 5.5% '13s for $86 and $91.25 respectively.

BoneYard expects this to continue as there are multiple benefits to the REITs. Prices have been increasing, so the opportunity is getting less compelling.

Disclosure: Long PLD and REIT debt.

Comments

[Emerald:]

Buying back debt at a discount is a clear financial benefit and saves on interest expense. However, be careful of companies staring into the financial abyss of lower rents and higher tenant improvment costs, especially retail and office REIT's. Make sure thery have refinanced upcoming debt maturities for '09 and '10 and have acccess to credit lines. The best bets are apartment REIT's who have repurchased and refinanced debt and have access to Fannie Mae debt such as Equity Residential and AvalonBay. Note: Long EQR.

May 08 11:11 AM

[Dave Shafer:]

Companies that are repurchasing debt are telling you that they can't put the debt to use for a greater return. Now, this might be a good sign in that they can get rid of excess leverage and pump earnings by doing it, but then again the core business is real estate and if they can't make money doing it, then there are long term issues that need to be addressed!

May 08 11:25 AM

[Living4Divi...:]

Dave Shafer - The economy is on a downswing and their is excess capacity. Even though there are bargains galore, no REIT wants to expand right now. And, it would be silly for them to be expanding in this market.

The REITS sold their debt for $1.00, then the market got panicky and the REITS bought back their very own debt for $ 0.70. Meanwhile, the REITS lowered their leverage. And they pay for it out of cash flow by cutting cash dividends to investors and replacing the dividends with stock.

This is very smart on the REITs part and sounds like a good deal for the shareholders, except for the ones that were depending on the dividends for retirement income. Even then, the REIT distributes $10 in shares or $10 in cash, what's the difference? The investor could sell the dividend shares for income at the 15% cap gains rate.

May 09 01:53 PM

[Baboon:]

The difference is that in one case they distribute to the shareholders hard cash and in another worthless piece of paper. If it wouldn't make any difference from reit's standpoint I doubt there was any need for them to do that. How is it possible at the same time to keep cash to themselves and at the same time to distribute what's considered to be it's cash equivalent to the shareholders? Something should be worthless.

Even then, the REIT distributes
> $10 in shares or $10 in cash, what's the difference? The investor
> could sell the dividend shares for income at the 15% cap gains rate.

May 09 02:08 PM

[Dave Shafer:]

Yes, REITS are expanding. Try the health care REITS for example.
You generalize much to much!

May 13 03:18 PM

[User 435305:]

Baboon - when reits hold cash and issue shares, the shares are claim to that additional cash. They are not worthless.

They can either distribute cash or new shares to account for the new assets (cash) in the business. Remembers shareholders "are" the company.

Jun 22 09:35 PM