REIT management teams have been saying that they learned some important lessons from the global financial crisis that pushed them to shore up financial strategies and improve liquidity. Those lessons are being put to work amid mounting financial pressures emerging in the wake of COVID-19.
“The best time to make strategic moves is before a crisis, not during it,” says Todd Kellenberger, REIT client portfolio manager at Principal Global Investors. “Many REITs took those lessons from the last downturn and made a strategic decision this cycle to strengthen balance sheets by reducing leverage, extending and staggering maturities, and ensuring that they have the liquidity and cash on hand to be opportunistic or weather the next storm.”
The listed REIT market certainly entered the economic disruption caused by the pandemic on stronger financial footing compared to the eve of the great financial crisis. The majority of companies have delevered—with leverage ratios at the end of 2019 at or near their lowest level in more than two decades—and analysts tend to agree that most companies are relatively well prepared for a recession. REITs have also improved liquidity by expanding revolving credit facilities and increasing the use of unsecured debt.
At the same time, REITs are bolstered by last year’s record $109.36 billion raised in equity and debt from public capital markets, nearly double the $55.63 raised in 2018. Between 2009 and 2019, REITs raised $440 billion in equity capital.
“In most cases, we do not see a deterioration in this discipline and expect most REITs will benefit from solid balance sheets and robust liquidity near-term,” says Chris Wimmer, vice president, real estate at DBRS Morningstar. “That said, some sectors, such as lodging and discretionary retail, are feeling the economic brunt of the pandemic more than others. We view these property types as the more likely to exhaust liquidity in the near term,” he adds.
Although REITs are leaning on lessons learned in the 2008-2009 recession, management teams have been forced to adapt strategies to a highly fluid situation with a myriad of unique challenges. “The arc of history is that the past always rhymes, it doesn’t repeat,” says Michael Knott, U.S. head of REIT research at Green Street Advisors. The last recession was a financial crisis, while the current situation is a double whammy of a public health and economic crisis. “So, it is not balance sheets and liquidity being directly under fire, it is the durability of the cash flow promised by leases,” he says. “We’ve seen unprecedented government actions and the closing down of society that is pressuring the basic concept of a lease contract and the durability of cashflows that normally provides.”
Focus on Preserving Liquidity
The pandemic swept through global economies with amazing speed, triggering business closures and a spike in unemployment that put REIT cash flows in jeopardy. REITs responded quickly by taking steps to maintain liquidity in order to sustain operations in a highly uncertain and still volatile climate.
Across the board, REITs have suspended earnings guidance for the rest of the year, followed by moves to tap lines of credit, suspend or reduce dividends, halt share buyback plans, reduce executive compensation, and delay cap-ex and development projects.
“In general, the collective memory of the downturn in 2008 and 2009 is still pretty fresh. So, you have seen some pretty aggressive steps being taken in terms of preserving liquidity and maximizing flexibility,” Knott says.
Specifically, companies have initiated massive drawdowns on lines of credit with some staggering numbers in some cases, notably in the lodging sector. REITs also moved quickly to make changes to their dividend payouts.
Park Hotels & Resorts Inc. (NYSE: PK) said it would suspend dividend payments following the payment of its first quarter 2020 dividend. Macerich (NYSE: MAC), meanwhile, was one of the first REITs to cut its dividend. The company announced March 16th that it would not only reduce its dividend by one-third, but also pay a majority of the remaining dividend in stock.
In response to efforts by Nareit to help REITs conserve capital, the Treasury Department and the Internal Revenue Service said May 4 that public REITs could use up to 90% stock to satisfy their distribution requirements through 2020.
Another strategic move has been extending lines of credit where possible. For example, Simon Property Group, Inc. (NYSE: SPG) expanded its line by $2 billion and extended it three years by pushing it out to 2025. “That is not as sensational of a headline as someone drawing down their entire line of credit, but it is a very good liquidity-preserving move,” Knott says.
For its part, Camden Property Trust (NYSE: CPT) further strengthened its liquidity position with the issuance of a 10-year, $750 million senior unsecured note. That deal represented the REIT’s largest ever bond issuance, as well as its lowest ever coupon on a bond. The deal also helped to reopen the bond market, notes Alex Jessett, CFO at Camden. “We are very hopeful that the rest of our REIT brethren will take advantage of that, because we believe that the stronger we are as an industry, the more beneficial it is for each of us individually,” he says.
As of mid-May, Camden was sitting on about $1.5 billion in liquidity, including almost $600 million of cash and cash equivalents and no outstanding amount under its $900 million senior unsecured credit facility. Camden doesn’t have any debt maturities until 2022, when it has $100 million in January and $350 million in December.
In addition, the REIT put a temporary delay on a planned development in Plantation, Florida where only minor site work had been completed. It made sense to temporarily delay that project out of an abundant sense of caution and with the hope that the REIT may be able to obtain some additional pricing power in construction costs in the coming months that could be beneficial, Jessett says.
REITs Adopt Defensive Strategies
REITs across the board have moved into a more conservative “just in case” mode of cash preservation. That was especially the case at the early onset of the coronavirus in the U.S. in late February and early March, amid panic on Wall Street that was fueling uncertainty on how financial markets might hold up during the pandemic.
For those that had lines of credit, it was better to draw on that cash, because they weren’t sure if they would have the ability to do so later if they waited, Kellenberger notes. “Since then, we have seen tremendous amount of backstop from a fiscal and monetary standpoint, really ensuring that there is ample liquidity in the broader financial markets,” he says. Nonetheless, REITs have continued to execute on different strategies ranging from upsizing lines of credit to putting a freeze on new hiring.
“We run our business very conservatively and felt that it was prudent to enhance our cash position during this time of uncertainty,” says Sumit Roy, president and CEO of Realty Income Corp. (NYSE: O).
The company had raised approximately $730 million in equity in late February at favorable pricing. In addition, the REIT has taken a number of steps, including borrowing an additional $1.2 billion under its revolving credit facility and pricing a 10-year, $600 million bond issuance that put its total liquidity position at $2.9 billion as of mid-May.
“As we modeled our capital needs into the next year, we overlaid fairly draconian downside scenarios and determined it was in the best interest of our shareholders to prepare for the worst—and then some, and to build our cash reserves as an insurance policy,” Roy says.
Those measures give Realty Income financial flexibility to cover potential liquidity needs in the near-term without having to rely on what could be an increasingly volatile capital markets environment, Roy notes.
One move the REIT has not made is reducing its monthly dividend, which it views as an integral part of the firm’s brand as the “monthly dividend company.” “While we do not anticipate any changes to our dividend strategy going forward, this is another financial lever available to us, although we continue to view the dividend as sacrosanct,” Roy says.
Lodging, Retail Bear the Brunt
REITs across the board face challenges ahead with the Federal Reserve’s economic forecasts for 2020 predicting a contraction in GDP of 6.5% and an unemployment rate of 9.3%. However, the impact will be very different across property sectors and geographic regions.
Hospitality and retail cash flows have been hit hardest by the business shutdown and tenant requests for rent relief. In addition, some geographic markets have been more severely impacted by others. For example, Los Angeles has said that it could extend its lockdown order through July. Additionally, economies that rely more heavily on tourism and convention business, such as Las Vegas, Orlando and San Francisco, face a tougher recovery ahead, even as businesses begin to reopen.
Lodging REITs have had to respond quickly to a freefall in occupancies and revenues. Park Hotels & Resorts, for example, moved aggressively by drawing down its entire $1.3 billion line of credit as it has more leverage on its balance sheet than its peers due to a prior M&A deal, Knott notes.
Host Hotels & Resorts, Inc. (NYSE: HST) also drew down its entire $1.5 billion line of credit and is sitting on almost $3 billion in cash, Knott says. That shows how both ends of the spectrum are taking similar steps, which points to the severity of the situation related to diminished cash flow and deep challenges facing the hotel sector, he says.
“For retail and hotels, we expect near-term cash flows to be impacted meaningfully,” Kellenberger adds. That being said, most companies have been able to draw on lines of credit or revolvers or rely on cash on hand that will allow them to go through a cash burn for an extended period of time. Other sectors that are experiencing very little rent defaults or deferrals are in a stronger cash flow position and would be able to weather a downturn or recession for an even longer period, he adds.
Many REITs in the lodging, gaming, and retail sectors have reduced or suspended dividends. “That makes sense. Those companies won’t be rewarded right now if they continue to pay cash out when they are likely to have so little coming in the door,” Kellenberger says.
Poised for Opportunities
It remains to be seen how deep and how long the COVID-19-related financial crisis may last and it is unlikely that REITs will escape the current economic challenges unscathed. Management teams will still need to operate carefully, keep close tabs on their portfolios, and execute careful strategies to deal with the impacts of the pandemic.
However, strong balance sheets will buy REITs more time in being able to weather the storm, and for some, the ability to access dry powder puts them in a good position to capitalize on opportunities that may arise to add value for shareholders.
“When we went out and made a conscious decision to have one of the best balance sheets in the REIT industry, it certainly wasn’t so we could congratulate ourselves on an achievement. It was because we recognized that those REITs that had the best balance sheets were the ones that were going to produce over the long period the best shareholder return,” Camden’s Jessett says. “Very strong REITs have the ability to take advantage of opportunities when others are sitting on the sidelines. So, we certainly will be looking to take advantage of opportunities out there.”
A Silver Lining
Camden isn’t the only REIT on the lookout for expansion opportunities. During recent video interviews with Nareit, several REIT CEOs expressed confidence that they would be in a position to expand their businesses in the wake of the coronavirus crisis.
Ramin Kamfar, chairman and CEO of Bluerock Residential Growth REIT, Inc. (NYSE American: BRG) said the REIT is fortunate to have a “significant amount” of cash and access to capital. The REIT has already signed up one post-COVID deal and is looking at additional opportunities. “We think there’s going to be plenty of opportunities to take advantage of as we go through this downturn,” he said
Agree Realty Corp. (NYSE: ADC) increased its acquisition guidance for the year to $700-800 million at the end of April from $600-700 million. Joey Agree, president and CEO, said “we’re seeing a lot of opportunities given the dislocation we see in the market today.”
Lou Haddad, president and CEO of Armada Hoffler Properties, Inc. (NYSE: AHH), noted that this is the fifth recession the REIT has weathered. The company’s response to the crisis has been to work with tenants, conserve cash, and get ready to outperform its peers once the crisis clears. “We want to be ready to take advantage of what should be a lot of opportunities in the market come the latter part of this year and 2021,” Haddad said.
Kimco Realty Corp. (NYSE: KIM) CEO Conor Flynn said the REIT is “well-positioned” to take advantage of market dislocation, noting that the Kimco has prepared for a downturn by transforming its portfolio and prioritizing liquidity. “This time around we’re in a position to be opportunistic, recognizing that we do think there’s going to be some dislocation both from the private side and from potentially the public side,” Flynn said.