What is in this article?:
- Flexibility, Attractive Rates Fuel Public REITs' Appetite for Unsecured Debt
- Top-Notch Credit
There are times when the unsecured debt market is open and the secured market isn’t.
Public REITs are known for their deep pockets thanks to their ability to tap both traditional mortgage debt as well as public equity. REITs are expanding their capital options even further with a growing appetite for unsecured debt.
Veteran REITs such as Kimco Realty Corp. have been using unsecured debt as a capital source for the past two decades. “We look to be opportunistic where we can and use the different capital sources that are available to us,” says Glenn Cohen, CFO of New Hyde, N.Y.–based Kimco.
There is an ebb and flow to the unsecured debt market as pricing and availability fluctuate along with interest rates and buyer demand. Over the past two years, that capital has been readily available, and REITs are taking full advantage to increase issuance of unsecured senior notes to refinance properties as well as fund operations and expansion strategies.
In May, Kimco completed an offering of senior notes that it raised $350 million, which it used to refinance existing notes that were maturing this year. “We went to the market at what turned out to be a very, very opportune time,” says Cohen. The maturing notes were issued at rates ranging between 6.125 percent and 4.700 percent, well above the 3.125 percent the REIT was able to obtain in May, when the 10-year Treasury was at 1.96 percent. In fact, that rate was the lowest 10-year coupon that Kimco has issued in the history of the firm.
Although Kimco uses a variety of debt and equity sources to fund its capital stack, Cohen admits that the REIT’s management prefers the unsecured debt market over the mortgage market. One of the big incentives to use the unsecured debt market is that capital can be accessed quickly. From start to finish, Kimco’s $350 million offering took just 48 hours to complete. In contrast, putting together the same financing in the secured debt market would require obtaining mortgages on multiple properties, a process that would probably have taken at least 90 days.
It typically takes about a week from the time a company decides to issue in the bond market to creating the necessary offering documents, announcing the issuance and closing the transaction. “That is pretty quick access to capital, which is attractive to companies,” says Steven Marks, managing director and head of the U.S. REITs Group at Fitch Ratings in New York. Mortgages for a single property, or a portfolio of properties, could take weeks or even months to secure in some cases.
Volume on the Rise
REITs are exhibiting a larger appetite for unsecured debt. The amount of capital REITs have raised through the unsecured debt market jumped in 2012 and continues to climb in 2013. U.S. equity REITs raised $25.7 billion in 2012—up 87 percent compared to 2011. That demand has carried over to 2013, with $17.6 billion in capital raised in secured debt issuance as of August 31, according to data from SNL Financial and NAREIT.
“The biggest reason that you see an increase in the use of unsecured debt is the same reason that you see an increase in equity issuance, which is that REITs are tapping the capital markets so that they have money available to buy properties,” says Brad Case, senior vice president of research and industry information at NAREIT. “What REITs are trying to do is reduce their overall cost of debt capital and at the same time maintain flexibility in the way they can use the capital that they raise, and that’s what unsecured debt gets them,” he adds.
One notable difference between REITs and other public companies is that they access the corporate bond market because they want to—not because they have to, adds Marks. The underlying assets that REITs own are quite financeable in the secured debt markets with mortgages from banks, insurance companies and CMBS lenders. So REITs choose to issue unsecured bonds for a variety of reasons.
A key factor fueling demand is favorable rates. Due to low interest rates and demand from bond buyers, the cost of unsecured debt financing is very attractive right now. “In some cases the all-in rates for unsecured bond issuance are lower than mortgage financing,” says Marks. Although the price differential between corporate bonds and a long-term mortgage varies depending on the asset and the credit rating of a REIT, in general a BBB-rated REIT could issue a bond at a 4.0 percent to 4.5 percent rate. At current interest rates, that is on par with or perhaps slightly better than a 10-year mortgage rate.
Yet the unsecured debt market is not without its challenges. Pricing shifts along with interest rates and demand from corporate bond buyers, and the market does ebb at times—including at the peak of the financial crisis during 2008 and 2009, when unsecured bond pricing for REITs was extremely unattractive. In addition, the unsecured market is more susceptible to external events such as turmoil in the Middle East, whereas the mortgage market moves more slowly.