Real Estate Investment Trusts

(REITs)

NYU Schack
Real Estate Capital Markets

April 18, 2016

MERRIE FRANKEL
Moody’s Investors Service
[Link]@[Link]
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Real Estate Industry and Capital Markets Trends
(via 4 quadrants)

Public Equity Public Debt

REITS/REOCs Bonds/CMBS/CDOs

Private Equity Private Debt

Mezz/JVs/Private REITs Mortgages/High Yield/Syndications

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 REITs- Definition
 A corporation (trust) that owns real estate and passes its
income and losses through to its investors without the entity
incurring income tax
 A “Mutual Fund” for real estate – allows real estate companies
to access the public markets
 Ownership Rules:
– Must have a minimum of 100 shareholders-- with no more
than 50 percent of its shares held by five or fewer individuals
– 75% of REIT’s assets must be invested in cash, government
securities and real estate
 Income Rules:
– 75% of REIT’s income must be from real estate sources -
rents, reimbursements, etc.
– Pay at least 90 percent of its taxable income in the form of
shareholder dividends each year; as a result, REITs may not
generally retain their earnings
– Less than 30% of gross income can be sales of real property
held less than 2 years (originally was 4 years)

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 REITS - HISTORY
 1960 Formed by an act of Congress

 1960’s Passive Equity REITS

 1969 - 1976 Mortgage REITS

 1970’s/1980’s Ignored due to Limited Partnerships

 1985 A few Real Estate Operating Companies

 1986 Tax Equity & Fiscal Responsibility Act Allowed Active Management

 1991 Kimco REIT started new ERA

 1992 Taubman created and UPREIT coined

 1992 - 1998 Real Estate Operating Companies Explode

 1998 Real Estate Capital Markets Pull Back

 1998 - 1999 REIT Stock Values Retrench; M&A Activity

 1999 - Present Mega REITs, Operating Companies, Financial Deals

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REIT Capital Structures

Basic REIT
Public

REIT

BUILDING BUILDING BUILDING

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REIT Capital Structures

Basic UPREIT
Public

REIT

UMBRELLA PARTNERSHIP

BUILDING BUILDING BUILDING

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REIT Capital Structures

Down-REIT Structure

Public

REIT
Third Parties

Down - REIT
Partnership

BUILDING
BUILDING
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 Growth in Number of REITs
(1975 – 2016)
250

200

150

100

50

Total Mortgage Hybrid Equity

Source: NAREIT at 3/31/16

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 Growth of REIT Market Capitalization
(1975 – 2016)
$1,000,000

$900,000

$800,000

$700,000

$600,000 Total
$500,000 Mortgage
$400,000 Hybrid
$300,000 Equity
$200,000

$100,000

$0

.
Source: NAREIT (in U.S. $ Millions) as of 3/31/16
Note: FTSE NAREIT Hybrid REIT Index was discontinued on 12/17/10.

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 Market for REIT Securities

 REIT investors’ preferences:

– Sector rotation to “Old Economy” stocks

– Compelling valuations (often 5-10% discount to NAV),

historically low FFO multiples, high dividend yields
(average 4-5% now, down from 7%)

– Strong underlying performance (continued FFO and

dividend growth, asset dispositions, stock repurchase
plans)

– Larger equity bases, liquidity, or “niche” plays

– High ROE and Economic Value-Added models

– Long-term cash flow growth potential

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Sector Strengths

 Platforms are stronger than ever: US REITs, particularly

investment grade, continue to expand in size, scope and
diversity while culling older, less productive assets

 Many REITs have adopted a “back to basics” business strategy

through simplified business models, which provides increased
transparency

 Liquidity is strong: manageable, near-term debt maturities,

ample bank line capacity, large unencumbered asset pools, and
access to all capital market quadrants

 Financial flexibility due to balance sheet strength

 Operating fundamentals are tracking the U.S. economy as it

continues to grow - despite U.S. fiscal drama
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REIT Trends 2009-2016

 REITs continued to do the “right” things in

2009-16:
– Focus on internal (“organic”) growth
– Sell mature and non-core assets
– Selectively issue equity
– Repay/refinance debt
– Joint venture with institutional investors

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 REIT Trends 2009-16 (con’t)

 How REITs differ from other equity investments?

– Hard assets; easy to understand business premise

– Investors willing to accept lower real estate type returns as

hedge against stock market

– Cash flow “protected” by leases

– Pay high dividends (formerly 7%, now approx 4%)

– Dividend payout ratios approx. 70% - 80% of cash flow

– Low leverage, averaging 40% of capitalization

– Interest coverage is high, at least 2 to 1

– Trade at approximately net asset value +/-

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REIT Trends 2009-16 (con’t)
 Issues and concerns
– High valuations compared to:
• Net asset values
• Dividend yield spreads over 10-year Treasury bonds
• Funds from Operations (FFO) multiples
– Dividends safe, but sometimes sell properties to cover
dividend
– Addition to S&P indices helped to broaden investor base, but -
• Fewer core investors; “Momentum” and “Yield” players may
rotate to the next “New” sector as corporate earnings
continue to increase
– Sharp increase in interest rates
– Too much equity issuance

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 Sources of Financing (con’t)

Sources of Financing--Debt & Equity- as of March 31, 2016

80,000
75,000
70,000
65,000
60,000
55,000
50,000
45,000
Millions

40,000
35,000
30,000
25,000
20,000
15,000
10,000
5,000
0
2016
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
YTD
Unsecured Debt 9,895 10,638 10,894 17,306 16,330 25,261 18,155 5,173 10,422 19,230 13,790 25,730 30,739 30,934 32,201 7,975
Common Equity 4,204 5,785 5,471 7,338 12,310 17,966 13,674 11,623 24,234 25,604 33,382 36,965 41,463 28,090 24,856 6,617
Preferred Equity 1,878 1,991 5,192 5,858 3,095 4,239 4,202 1,195 0 2,617 4,108 10,631 4,755 4,618 2,236 541
Total 15,977 18,414 21,557 30,502 37,492 49,018 36,031 17,991 34,656 47,451 51,280 73,326 76,957 63,642 59,293 15,133

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REIT Performance versus
Public Equity Securities Markets
REITs DJIA NASDAQ RUSSELL 2000

2016(YTD) +5.1% +3.7% -0.9% -0.2%

2015 +2.3% +0.2% +6.9% -4.4%
2014 +27.2% +10.0% +14.8% +4.9%
2013 +3.2% +29.57 +40.1% +38.8%
2012 +20.1% +10.2% +17.5% +16.4%
2011 +7.3% +5.5% -1.8% -4.2%
2010 +27.6% +11.0% +16.9% +26.9%
2009 +27.5% +18.8% +43.9% +27.2%
2008 -37.3% -33.8% -40.5% -33.8%
2007 -17.8% +6.4% +9.8% -1.6%
2006 +34.4% +16.3% +9.5% +18.4%
2005 +8.3% -0.6% +1.4% +4.6%
2004 +30.4% +3.2% + 8.6% +18.3%
2003 +38.5% +25.3% + 50.0% +47.3%
2002 +5.2% -16.8% -31.5% -20.5%
2001 +15.5% -7.1% -21.1% +2.5%
2000 +25.9% -6.2% -39.3% -3.0%
1999 -6.5% +25.2% +85.6% +21.3%
1998 -18.8% +18.0% +40.1% -2.4%

Source: NAREIT; Total return data; FTSE NAREIT US Real Estate Index as of 4/14/16
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U.S. REIT Unsecured Debt and Equity Issuance
(in Billions)

45.0

40.0

35.0

30.0

25.0

20.0

15.0

10.0

5.0

0.0
2016
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
YTD
Unsec Debt 16.3 25.3 18.2 5.2 10.4 19.2 13.8 25.7 30.7 30.9 32.2 8.0
Equity 12.3 18.0 13.7 11.6 24.2 25.6 33.4 37.0 41.5 28.1 24.9 6.6

Unsec Debt Equity

Source: NAREIT as of 3/31/16:

NAREIT; Moody’s
debt data excludes convertibles 19
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issuances by Kimco North Trust
III (CAD$700MM in 2005-2013);
 REIT Equity Performance
10 year 5 year 3 year 1 year YTD

50

45

40

35

30

25

20
Return (%)

15

10

-5

-10

-15

-20
Retail
Health Data Self All Equity
Office Industrial Multifamily (malls, Lodging Diversified Mtg REITs All REITs
Care Centers Storage REITs
sc,outlet)
10 year 3.7 -1.2 9.3 5.90 1 11.1 4.1 0 17 -1.3 6.5 6.1
5 year 7.1 9.7 12.7 14.9 5.6 8.7 7.6 0.0 26.8 4.8 11.6 11.4
3 year 7.5 8.4 16.3 11.2 5.9 1.3 7.1 0.0 28.2 -2.3 9.9 9.2
1 year -5.6 7.7 11.6 6.9 -16.1 -6.5 -3.0 0.0 42.8 -7.2 4.7 4.1
YTD 1.3 6.4 -2.9 7.8 3.9 5.3 1.9 12.3 6.9 5.1 5.0 5.1

Source: FTSE NAREIT YTD through 4/14/16; 1,3 & 5-yr Compound Annual Total Returns through 3/31/16

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 Market Size Comparison
1000000
$926,764
900000

800000

$700,000
700000
$609,070
600000
$ Billions

500000

400000

300000

200000

100000

0
Commercial and
REITs Market Cap (Equity + Apple
Multifamily
Mtg REITs) 1 Market Cap (largest Securitizations 3
US co by mkt cap) 2
Sources: (1) NAREIT 4/14/16; (2) NYSE, Yahoo Finance 4/15/16; (3) Federal Reserve, Flow of Funds
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Sector Trends
 Simplification- many REITs have simplified their business models
providing increased transparency
– Reducing non-strategic, domestic joint ventures and exiting
non-core businesses
– Targeting narrower, more dominant markets
– Platforms are stronger than ever: REITs continue to expand in
size, scope and diversity while culling older, less productive
assets
 Development/re-development gaining momentum
– Pipelines growing; expect trend to continue due to competitive
acquisition market causing development to become a driver of
growth
– Key factors: leadership and expertise, funding and risk sharing
• Credit focus on size and associated business risk
– Property operating fundamentals are improving, albeit at
different rates, across all sectors; lease spreads improving
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Corporate Strategic Trends
 REITs remain focused on strategic growth

– Acquisitions and developments in markets in which they are active in order to maintain
market leadership

– Continued disposition of non-core assets

 12 new ratings in 2014 and eight new ratings 2015

 M&A activity:

– Blackstone/Excel Trust

– Brookfield Asset Management/Associated Estates

– Cyrus One/Cervalis

– Digital/Telx

– Gaming and Leisure Properties, Inc./Pinnacle

– Lonestar/Home Properties

– Prologis/KTR Capital Partners

– Simon/WP Glimcher

 Spinoffs: IRS changed non-tax spinoff rules – will affect future REIT spinoffs. Completed:
Simon/Glimcher WP; Vornado/UrbanEdge; Westfield/Scentre;Ventas/Care Capital
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Shareholder Activism from a Credit Perspective
 Shareholder activism for public REITs has led to:
– Complete turnover of a firm’s management, board,
portfolio and operating strategy
– Sale to another public REIT
– Sale to a private fund or private equity firm

 Positive credit aspects

– Full restructuring has led to excess cash flows being used
to reduce debt
– Sales to other public REITs have led to larger and better
capitalized REITs

 Negative credit aspects

– Aggressive portfolio growth
– Aggressive use of leverage and secured debt
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

Capital Market Trends

 Attractive debt capital markets – good for liquidity;

challenging for acquisitions
 Liquidity is strong: manageable, near-term debt
maturities, ample bank line capacity, modest floating rate
debt exposure, and increasing unencumbered asset pools
 Access to all capital market quadrants
 Financial flexibility due to balance sheet strength

 Global Industry Classification Standard (GICS)-

implementation of new real estate sector GIC classification
by mid-2016 will raise profile of REIT sector and increase
fund flows

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Property and Capital Market Trends
 Development pipelines gaining momentum

 High prices/relatively low cap rates diminish prospects for accretive acquisitions

 Operating fundamentals remain strong

 Commercial paper issuance

– Appropriate for a handful of the highest rated REITs (Baa2 unsecured or above
to be P1/P2)

– Necessitates exceptionally strong liquidity given asset-liability mismatch

– Can subject a REIT to greater financial market volatility given CP issuers’ need
for continuous capital markets access

– Commercial paper programs reduce alternative liquidity by depleting bank line

availability; revolvers provide back-up liquidity support for CP programs

 Omnichannel- blurring lines between bricks and internet, but some Canadian retailers
are slow to adopt on-line strategy

 Urbanization- impacts most sectors

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Impact of rising rates on U.S. REIT credit
quality
 Moody’s Analytics forecast for the 10 year Treasury: 2.2% at
YE2015 and 3.1% at YE2016

 REIT ratings are well-positioned for expected increases

– Rated REITs eventually will have to refinance maturities at
higher interest rates
– They have sufficiently low overall leverage and strong cash
flows allowing refinancing without jeopardizing their ratings
– Real estate fundamentals remain strong, coupled with higher
occupancies and increasing rents
– Medium- to longer-term, we anticipate EBITDA growth to
provide additional cushion for REITs’ credit profiles and to help
offset interest rate increases

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Capital Markets – REIT/REOC Topics

 Low cost of capital: spreads enhance

investment opportunity
 Balance sheets: support growth, but also
protect in downturn
 Positive internal growth: increasing occupancies
and rents with low new supply
 External growth: acquisitions, redevelopment
and selective new development
 US bonds- investor discussion about additional
covenant to protect them in REIT
merger/acquisitions
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Capital Markets – Potential Pitfalls

 Competitive bidding environment:

REITs/REOCs tend to close on
private/negotiated basis; finding value-
added acquisitions and M&A difficult
 International/exogenous events- Asia,
Mideast…..
 Consumer sentiment and jobs - affect
most sectors
 Higher interest rates– rating holding over
short term; potential longer-term issue
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Improving Commercial Real Estate
Fundamentals
Strength and momentum varies by sector – Stable Outlook
 Office sector recovery is slow, but continues

– Improving demand dynamics

– Suburban struggling

– Low levels of development

 Multifamily continues with robust performance

– Strong fundamentals drive significant credit metric improvement

– Growth driven by development

– New supply may be an issue (e.g., condo construction)

 Retail occupancies and NOI growth continue to improve

– Smaller in-line stores remain the focus

– Growth mostly through redevelopment; some international expansion

– Consumer spending is a concern: unemployment and economic volatility

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Improving Commercial Real Estate
Fundamentals
Strength and momentum varies by sector

 Industrial experiencing increased leasing demand

– Less options for large block tenants
– New development increasing; some is speculative

 Healthcare outlook driven by demographic trends

– Aging population driving demand for services
– Potential consolidation

 Lodging performing well despite macroeconomic uncertainty

– New supply is low
– Margins expanding with improved occupancy and pricing
– Corporate segment leads; leisure lags
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REIT and REOC Industry Profile
Strengths

 Expanding size, diversity and scope

 Moderate leverage, manageable debt maturities and good

liquidity
 Stable key financial measures
 Unencumbered real property provides liquidity in distress,
boosting bondholder recoveries
 Access to all capital markets (public and private debt and
equity)

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REIT and REOC Industry Profile
Challenges

 Little capacity for cash retention with REITs, especially

after accounting for capital expenditures
 Leveraged joint ventures and fee-generation platforms
such as investment funds create complexities, risks and
earnings volatility
 Growing development pipelines and a focus on purchasing
value-added properties with high vacancies
 Widening risk premia and sharper refinancing difficulties
for secondary-quality individual properties, property types
and locations of secondary quality
 Rising interest rates will pressure fixed-charge coverage
metrics, albeit from historically low interest rate levels
and high coverages
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Equity Valuation of REITs

 Forward FFO multiples

 Real Estate Value
– Net Asset Value (NAV)
– Forward Asset Value (FAV)
– Implied cap rates
– Implied price per unit PSF
 Enterprise Value (EV/EBITDA)
 Yield – Implicit total returns

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 International Expansion
 REITs/REOCs are expanding outside the US, often through JVs
or funds
• Joint Ventures with US REITs entering Canada:
RioCan/Kimco for many years, Simon/Calloway,
RioCan/Tanger

 Benefits: growth/earnings potential, platform expansion,

diversification, growth, leveraging skills in new markets, and
serving international tenants

 Concerns: governance, management, legal, currency, political,

liquidity, tax, exit and “other”

 Firms must have infrastructure to properly manage portfolio

 Often through JVs or funds, but seeing more whole investment

 Moderate risk- credit focus on transparency, business risk,

control, and other matters

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International REITs

 Growing number of public property firms/funds;

formation of REITs
– Japan, Hong Kong, France, Netherlands,
Malaysia, Taiwan, Mexico, Canada,
Singapore, Belgium, New Zealand, Australia
for awhile
– Ireland, South Africa- 2013
 Tend to use US REIT rules (with minor
variations)

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International REITs

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Global REIT Returns (FTSE EPRA/NAREIT Global REIT Index 2/1/16)

US REITs Global Asia/Pacific Europe Middle East/

REITs Africa

2010 28.00 20.03 16.25 8.68 37.17

2011 3.99 -8.14 -19.74 -13.38 -18.20

2012 17.65 29.85 48.10 31.31 33.20

2013 -0.72 2.24 1.34 14.78 10.46

2014 26.19 14.73 2.08 9.47 14.96

2015 0.71 -0.41 -4.58 6.06 -15.31

2016 5.38 5.20 6.22 1.36 19.77

(YTD 4/14/16)

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 Rating
Methodology

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Average Cumulative Expected Loss:
Senior Unsecured Debt

30%

20%

10%

0%
B
Ba 16 19
Baa A
7 10 13
Rating Aa 4
Aaa 1 Years Out

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REIT/REOC Rating Drivers

 Achievement of strong sector leadership

 Steady earnings growth, with stability
 Portfolio diversification by tenant, industry and geography
 Capacity to fund at least recurring capex with retained
cash – post-dividends
 Increase in JVs and funds/fee-generating structures,
which often create weaker transparency, complexity,
management difficulties and earnings volatility
 Moderate financial leverage and maintenance of a robust
unencumbered asset pool may be affected by shifting
bond covenants

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Ratings and Market Fundamentals Broadly
Stable
Rating Outlooks – Canadian and
U.S. Rated REITs & REOCs

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Quantitative Approach
 Ratios that Moody’s focuses on:
– Fixed Charge Coverage
– Total Debt/Gross Assets
– Total Debt + Preferred Equity/Gross Assets
– Secured Debt/Gross Assets
– Secured Debt/Total Debt
– Unencumbered Gross Assets/Gross Assets
– Encumbered Gross Assets/Gross Assets
– Unencumbered NOI/Total NOI
– Total Unsecured Debt/Unencumbered NOI
– Unencumbered Gross Assets/Total Unsecured Debt

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REIT Financial Snapshot
 Leverage has been relatively stable

 Liquidity is sound in most companies

 Refinancing risk is manageable for most co’s

 Fixed Charge is stable

 Operating Margins are weakening

 Dividend Payouts are increasing

 Investment Yields are tightening

 Preferred Stock Redemptions are a rate play

 Unsecured Note tender offers – increased while interest rates

were down and when co’s wanted to change covenants

 Bank and Bond Covenants provide discipline

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 Rating REITs and REOCs:
What Moody’s Looks For
 Management Quality and Structure
 Financial Disclosure and Corporate
Governance
 Financial Flexibility
 Diversity with Depth
 Asset Quality
 Profitability
 Capital Access and Balance Sheet
Management
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Summary of REIT/REOC Scorecard
Broad Rating
Broad Rating Factor Factor Weight Rating Sub-Factor Sub-Factor Weight
Liquidity Coverage 8.00%
Upcoming Debt Maturities 6.25%
Liquidity and Funding 24.5%
FFO Payout 4.00%
Amount of Unencumbered Assets 6.25%
Debt + Preferred/Gross Assets 9.00%
Leverage and Capital Net Debt/EBITDA 9.00%
30.5%
Structure Secured Debt/Gross Assets 6.25%
Access to Capital 6.25%
Franchise/Brand Name 4.00%
Gross Assets 4.00%
Market Positioning
22.00% Diversity-location/tenant/industry/economic 4.00%
and Asset Quality
Development % Gross Assets 5.00%
Asset Quality 5.00%
EBITDA/Revenues 6.00%
Cash Flow and EBITDA Margin Volatility 3.00%
23.0%
Earnings Fixed Charge Coverage 9.00%
JV/Fund Business % Revenues 5.00%
Total 100.0% 100.0%

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 Sample Scorecard
Rating Factors
Federal Realty Investment Trust

Rating Drivers Aa A Baa Ba B Caa Ca Implied Score Adjusted Score Trend

Liquidity & Funding Low A Low A Neutral
Liquidity Coverage Good
Debt Maturities 7.7%
FFO Payout 73.3%
Amount of Unencumbered Assets 87.6%
Leverage & Capital Structure High Baa High Baa Neutral
Debt + Preferred/Gross Assets 40.2%
Net Debt/EBITDA 5.3x
Secured Debt/Gross Assets 6.7%
Access to Capital Excellent
Market Positioning & Asset Quality High Baa Low A Neutral
Franchise/ Brand Name Excellent
Gross Assets $6.3
Diversity-location/tenant/industry/economic Good
Development % Gross Assets 9.7%
Asset Quality Excellent
Cash Flow & Earnings Mid A High A Neutral
EBITDA/Revenues 64.4%
EBITDA Margin Volatility 1.7%
Fixed Charge Coverage 4.2x

JV/Fund Business % Revenues

Overall Assessment
Implied Score Low A
Adjusted Score Low A
Data as of September 30, 2015

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Ratings Approach: The “Credit Pyramid”

QUALITATIVE
ANALYSIS
Management
Strategic Direction
Financial Flexibility

QUANTITATIVE ANALYSIS
Financial Statements
Past Performance
Projections

MARKET POSITION

COMPETITIVE TRENDS IN SECTOR

Global / Domestic

REGULATORY ENVIRONMENT
Global / Domestic

SECTORAL (INDUSTRY) ANALYSIS

MACRO-ECONOMIC ANALYSIS

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Rationale for Moody’s Methodology

– Global consistency across property space

– Evaluation of operational, financial and
other industry criteria
– Mapping in accordance with key rating
factors
– Strong transparency of criteria and
process

Transparency is Key

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Moody’s Four Key Rating Factors

1. LIQUIDITY AND  Ability to service and repay debt

Adequacy of liquidity sources
FUNDING

 Pledgeable, unencumbered assets
 Funding structures, debt maturity laddering,
dividend coverage

2. LEVERAGE AND CAPITAL  High leverage drains cash resources

Structural subordination, financial
STRUCTURE

flexibility, effects of secured debt
 Balance between secured / unsecured debt,
recourse / non-recourse debt
 Stock Market Valuations & Bond Pricing

3. MARKET POSITION AND  Market leadership depth and breath

Size and Asset Market Value
ASSET QUALITY

 Portfolio diversity:
asset/location/tenant/industry/economic
 Development activity

4. CASH FLOW AND  Earnings momentum

EARNINGS  Earnings volatility
 Fixed Charge Coverage
 Joint ventures/fund businesses contribution
to earnings

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What’s Next?

 Succession planning

 Bifurcation between strong and weak

 European markets as yet untapped

 M&A – more than usual - Glimcher/Washington Prime

(WP Glimcher); BioMed Blackstone; Associated
Estates/Brookfield; Excel Trust/Blackstone

 More spinoffs? Will be a lull until understand new

spinoff regs

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 “Merrie - may I be excused? My brain is full”.

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