Real estate investment trusts are expected to be net sellers as they try to weed out unprofitable properties and bring their debt liabilities in line with the expected sinking value of the properties in their portfolios.
“A lot of people are expecting commercial real estate to be the next shoe to drop,” said Sarah M. Snyder, investment consultant in the real estate consulting group at Callan Associates Inc., San Francisco.
It all comes down to debt. REITs typically have less leverage across their portfolios than non-core private real estate investment managers. But debt was so cheap and easy to come by during the past few years that some REITs couldn't resist. A bit more leverage did wonders for a portfolio's returns. Even the most conservative REITs bumped up the debt on certain properties to give returns a boost, industry insiders say.
And these were equity REITs. The woes of mortgage REITS such as CBRE Realty Finance Inc. were first to hit the papers, but they make up just 6% of the overall REIT market, said Brad Case, vice president of research and investor information at the National Association of Real Estate Investment Trusts, Washington.
“When the downturn started, it was really a case of the tail wagging the dog,” Mr. Case said.
Not only were mortgage REITs hit hard, but also investors shied away from apartment and other residential REITs, Mr. Case said.
Industry consultants and fund of funds managers estimate that more than 10% of REITs packed on the debt. Equity REITs had average leverage of about 40% as of Sept. 30, 2007, but 45% were carrying more than 50% debt, according to NAREIT.
Mall REIT Centro Properties Group, Melbourne, Australia, is fast becoming the REIT industry's Enron Corp. If officials don't refinance $4.9 billion in outstanding debt by April 30, Centro will have to sell its properties — a good portion of which are in the United States — at fire-sale prices. But it is not alone. REITs such as Macquarie Office Trust, Maguire Properties and Allco Commercial REIT have put properties up for sale because they need the cash to pay off their debt. The falling value of their portfolios is causing their liabilities to increase beyond the value of their assets and could cause them to break the covenants in their lending agreements.
“Over the last five years, adding debt was an exceptionally good strategy,” said David J. Oakes, chief investment officer of Developers Diversified Realty Corp., Cleveland.
REITs informally have set a rule of 40% to 60% leverage to enhance returns without changing the portfolio's risk profile, Mr. Oakes said.
“But some companies took leverage to much, much higher levels ... running 80%,” he said.