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There are times when the unsecured debt market is open and the secured market isn’t.
The golden ticket to accessing the unsecured debt market is obtaining an investment grade credit rating, which opens doors to greater buyer demand and better pricing. These days, REITs are more mindful of both obtaining and keeping that investment grade credit rating.
First Potomac Realty Trust has not raised capital by issuing unsecured bonds, but it would like to. The REIT, which is currently not rated by the agencies, is positioning itself to obtain an investment grade rating.
As part of that goal, the company announced its strategic capital plan in January that included raising significant equity to pay down debt and improve the balance sheet. For example, the REIT sold its industrial portfolio earlier this spring for $259 million, and completed a public offering of common shares in May that raised $105 million in equity.
Public companies have access to public equity and private equity through joint venture partners, as well as access to secured debt in the mortgage market. “But, there are times when the unsecured debt market is open and the secured market isn’t,” notes Andy Blocher, executive vice president and CFO at Bethesda, Md.–based First Potomac. REITs such as First Potomac want that access and the greater flexibility that comes with being able to tap a full range of capital sources. “As our business grows, through good times and in bad, we want to have access to capital in order to fund what it is that we need to do,” he adds.
Maintaining an investment grade credit rating means adhering to stricter covenants and tighter controls on leverage, but that is a trade-off that many REITs are willing to make in exchange for greater access to capital. For example, Kimco pays close attention to key metrics such as its net debt to earnings before interest, tax depreciation and amortization, debt service coverage ratios and fixed charge coverage ratios. REITs also have to adhere to covenants such as a total debt to total asset test, a secured debt to total asset test, a fixed charge coverage test and an unencumbered asset test.
“You need to be very cognizant of those and make sure that you stay in compliance,” says Cohen. Kimco has an investment grade credit with a BBB+ rating for its senior unsecured debt by S&P and Fitch Ratings and a Baa1 rating from Moody’s.
“Having many alternatives of raising capital, especially in the real estate sector, is crucial,” Cohen adds. Companies that only use secured debt can get into trouble if property cash flows decline. “We look to be opportunistic where we can and use the different capital sources that are available to us.”
In fact, REITs are not only able to tap the U.S. bond market but also international markets. In July, Kimco issued $200 million in seven-year unsecured bonds in the Canadian bond market to fund some of its assets in that country. “It is a pretty vibrant market today. There is a lot of liquidity and a lot of demand for yield. So it is a good time to be a borrower,” adds Cohen.