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July 05, 2019  

Use of Commercial Paper by REITs Draws Fire

Large REIT-bond investors are voicing concerns about an emerging trend: issuers selling commercial paper to help finance property purchases.

At least four REITs paved the way for the short-term borrowing option in the first half, joining just two that had done so previously. The investors argue that using 30-day notes to fund long-term holdings is a recipe for disaster and that any disruption in the commercial-paper market could reverberate through the REIT sector.

They’re also concerned that once REITs start up commercial-paper programs, they will be tempted to continue expanding them. Indeed, Simon Property, which was the first REIT to begin issuing the short-term, unsecured notes in 2014, initially assured investors it would cap the program at $500 million — but has since upped its capacity to $2 billion.

“This is financial crack,” said a bond buyer at a major insurer. “It’s a matter of logic that if you can save some money by issuing $500 million in commercial paper, why not save more money by issuing $1 billion?”

The savings can be as much as 50 bp compared to the interest rate on a revolving credit facility from a bank, sources said. What worries some large REIT-bond investors is that if one firm gets into trouble and can’t roll over its paper, the market could freeze, and spreads on both the short-term notes and unsecured REIT bonds could widen dramatically.

REITs pursuing the strategy describe it as just another financing tool that will diversify their sources of capital and provide a less-costly alternative to revolving credit facilities. Their industry group, Nareit, downplays the issues raised by bond buyers, pointing to REITs’ strong financial position and generally conservative approach to financing.

“Those would be very valid concerns if you saw a company making other risky moves on their balance sheet,” said Calvin Schnure, an economist at the trade group. “Instead, they have de-risked their balance sheets, extended maturities of their debt, and are here getting low-cost funding” that doesn’t add significantly to the firms’ overall debt loads.

According to Nareit data, overall REIT leverage has fallen sharply over the past decade. The debt-to-assets ratio is 50.6%, down from a peak of 58.3%. What’s more, on a weighted-average basis, REITs paid 4% interest on long-term debt in the first quarter, down 200 bp from 2009.

In January, Ventas Realty and Welltower each announced commercial-paper programs of $1 billion. Crown Castle International followed in April with a $1 billion program, and in May, Mid-America Apartments opened a $500 million program. They joined Simon and Equity Residential, which has had a program running since 2015.

As of the end of the first quarter, Simon had $1.3 billion of commercial paper outstanding, Equity Residential $344.8 million and Ventas $194.5 million. Crown Castle hadn’t yet tapped the market, while Welltower and Mid-America didn’t specify any commercial-paper sales in their earnings reports. None of the companies responded to requests for comment.

So far, rating agencies have taken the programs in stride. An analyst at one agency said REITs entering the commercial-paper market tend to be highly rated, and noted that all have bank credit lines as backstops. “Done at a moderate level, it is something we view as neutral” from a credit perspective, the analyst said.

The complaints have come from some of the largest REIT-bond buyers. Most recently, they gave issuers an earful in private meetings during Nareit’s conference last month at the New York Hilton Midtown. Critics say there’s a big difference between revolving credit facilities, negotiated privately between REITs and banks, and commercial-paper issuance, which is public and subject to changes in market conditions as well as headline risk. In addition, they argue that once a REIT issues commercial paper, it tends to continually roll it over.

“It is very true that spreads are tight and REITs have been very disciplined,” said the buyer at the insurance company. “That is one of the arguments we have made as investors: nothing is broken. Why are you tempting fate by introducing financing that is inappropriate for your use?”