Co-produced with Beyond Saving and PendragonY for High Dividend Opportunities
When REITs File Bankruptcy: A Case Study
Property REITs or eREITs are not typical corporations. They receive favorable tax treatment, but that comes with rules that they have to follow. The requirement to distribute 90% of their taxable income means that REITs are great investment vehicles for investors who are looking for cash flow.
On the other hand, the distribution requirements limit how much cash REITs can retain and forces them to use capital raises for expansion. If prices are good, REITs can use common equity, but there is always the temptation to use debt for leverage. REITs are leveraged vehicles and strategic use of debt can greatly increase returns and provide greater income for equity. Being overly aggressive can prove to be problematic.
At HDO, we have focused a lot on finding high-yield preferred equity opportunities, especially among REITs. As an asset class, we view preferred equity in eREITs to be a very conservative investment. Yet even in a conservative asset class, we must be aware of the potential risks.
Today, we will look at the experience last recession and how bankruptcy impacted preferred investors. We will look at the types of warning signs investors should look for and how the value of the underlying property helps protect preferred equity investments.
How Many Bankruptcies
One overlooked benefit of eREITs is how resistant they are to bankruptcy, even during periods of severe economic trouble. From 2007-2010, the US went through the worst recession since the Great Depression. The recession was primarily driven by residential real estate and the financial failure of major real estate lenders. If there was ever a time for REITs to go bankrupt, it was then.
There was certainly a lot of fear and significant downward
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