REIT Stocks

BY: Susan Futterman

As share prices of publicly traded real estate investment trusts (REITS) continue to trade at or near their 52-week highs, an increasing number of REITS are taking advantage of that strength to raise cash now in order to repay debt or finance new acquisitions.

From mid-August to mid-September, four publicly traded REITS have closed a total of five PIPE transactions representing roughly $120 million. Summit Properties led the group, with a sale of common stock totaling nearly $50.2 million; followed by Mid-America Apartment Communities, Inc., with two separate transactions involving sales of common, each representing in excess of $19 million. Utilizing convertible preferred stock, Florida-based Commercial Net Lease Realty concluded a $25 million PIPE, and Northern Carolina-based BNP Residential Properties has closed a transaction totaling nearly $5 million.

REIT issuance continues at last year’s strong pace, on track to again reach $500 million by year-end. “It’s not so much a capital need for these guys, it’s more that they are taking advantage of robust stock prices,” comments Rob Stevenson, an analyst with Morgan Stanley. “They using the [PIPEs] to pay back debt and to call back preferred stock or higher-interest rate debt.”

In July, Ohio-based Health Care REIT closed a direct placement deal for 1,583,100 shares of common stock with clients of Cohen & Steers Capital Management, a leading REIT investment manager. The net proceeds of approximately $48 million were used “first to pay down a revolving line of credit, and ultimately invest in our health care facilities,” said Raymond W. Braun, the REIT’s president and CFO. “We maintain a certain leverage ratio, and it was time to do some equity in order to keep the debt-equity ratio in balance.”

In its April letter to shareholders, Cohen & Steers noted that the growing number of closed-end mutual funds that invest exclusively in REITs has provided an additional source of permanent demand for publicly traded real estate investment trusts, adding “Over $4 billion has been raised within this structure, and we expect more new funds to be created in the near future.”

One of the most recent of these funds is Scudder RREEF Real Estate Fund II, which began trading in late August. Together with Cohen & Steers, it acquired 665,000 shares of Tennessee-based Mid-America Apartment Communities. at $29.36 per share, slightly more than a point below the REITs closing price for the day of $30.42. Net proceeds from the sale, after deducting expenses, were estimated at approximately $19.5 million.

On the same day, Summit Properties announced it planned to sell 2.3 million shares of its common stock to clients of Cohen & Steers at a price of $21.81, a 1.76% discount from the previous day’s closing price.

Such transactions are quicker, cheaper and more efficient than a public offering, commented Gregg D. Adzema, executive vice president and CFO of North Carolina-based Summit Properties. He expects REITs to make increasing use of such transactions, noting that they not only eliminate many of the price risks inherent in public stock issues, but that buyers are typically institutional, and thus long-term, investors.

While raising capital through the use of debt has its place, direct equity placements – often used to retire high-priced debt – are a good balance-sheet management tool,” he added. “You issue equity when you have a good use for the proceeds. If the numbers work, then it makes sense to issue equity.”

However, the often-discounted level at which the shares are priced prompts some observers to worry that the exchange-listed share price is artificially inflated. “That [discounting] puts a cap on what I believe the stock is worth,” Stevenson noted. “If you’re willing to sell stock privately at that level, you believe the stock is overpriced.”

Adzema dismissed concerns that the stock price is inflated, contending that the discount at which the shares are issued has nothing to do with their fair market value. While the shares usually sell at a discount to the market price, the seller’s costs are still less than those for other transactions, Adzema added. “How dilutive such a transaction is depends entirely on what the proceeds are used for. In some cases, the process can actually be accretive; it just depends.”

Braun agreed, noting that direct placement is significantly less expensive than a secondary public offering. “There's always a cost of issuing shares,” he said. “We view direct placement as one source of capital, and we try to maintain different ways of accessing capital.”

Some analysts believe, however, that even apart from the impact of direct placements, REIT shares are overvalued. According to California-based Green Street Advisors, in September, the average REIT stock was trading at a 15% premium to the net per-share value of its underlying assets. That 15% compares to an average 4.3% premium over the past decade. Not only are REITS trading above their net asset values, many analysts believe that the shares are further inflated by artificially high values attached to the properties that underlie the REIT shares.

Not surprisingly, Cohen & Steers disagrees. “It is our opinion,” the company wrote in a June letter to shareholders, “that many analysts are underestimating REIT NAVs.” The shareholder letter went on to note that both current and future rental streams are at historic lows “suggesting that higher valuations are warranted.”

Cohen & Steers also points to other factors driving REIT asset values. It contends that not only does the replacement cost of REIT assets exceed most current value estimates of those properties, but that their prices can be expected to appreciate still further when the economy finally picks up its pace.