Public REITs have a key advantage over private real estate investors with their ability to tap into the bond market to access capital. That advantage has moved more to the forefront amid tighter liquidity for traditional mortgage financing. However, REITs are recognizing the importance of building and maintaining long-term relationships with fixed income credit investors across up and down market cycles.
REIT.com recently talked with Mark Streeter, managing director at J.P. Morgan, and Kevin McClure, director at Wells Fargo Corporate & Investment Banking, for their views on how fixed income credit investors are viewing public REITs and best practices to engage with that important group of bondholders.
How are REITs being viewed these days from a fixed income perspective?
Kevin McClure: In general, fixed income investors are constructive on REIT credit, much more so than they were at this point last year. Outside of office, REIT fundamentals remain in pretty good shape: occupancy is high, leasing spreads are positive, same store NOI is growing, and, most importantly, balance sheet leverage is low.
The bigger story, however, is how much REIT technicals have improved. It’s like night and day… and rate inflection was key, in my opinion. The 10-year Treasury peaking just north of 5% in October 2023 was the clearing event that the market needed. Once investors sensed that the Federal Reserve was done hiking and that rates had peaked, rate-sensitive products like REITs caught a bid, and markets opened up again. Year-to-date, investment grade traditional REITs have issued approximately $25 billion of corporate debt, deals have been well oversubscribed, and trading liquidity overall is better. Credit spreads are 13 basis points tighter year-to-date.
Mark Streeter: The last several years have been tough for REITs on the stock side because the Fed was either tightening or holding rates steady, and we're starting to see some of that performance gap be recaptured by REIT stocks as the Fed moves closer to cutting rates. REIT credit has actually done pretty well relative to the market year-to-date. After tracking the market for the most part in 2022 and 2023, in 2024 year-to-date, REIT credit has outperformed. That's because REITs historically trade a little wide to the BBB index, and we've been in a spread-tightening environment.
Office REITs, which are the REITs where credit spreads are widest, are still much less leveraged on their portfolios than the private market so they're much better able to weather the storm. Even though they're wide, we've seen a rebound in their spreads as well.
How has the higher rate environment impacted investors' fixed income strategies and/or investor expectations related to REITs?
McClure: REITs are attractive to fixed income investors for a number of reasons, but one major one is that the sector offers incremental yield pick-up relative to other investment grade sectors. For liquidity and other reasons, credit spreads for REITs tend to be higher than those of similarly rated investment grade corporates.
REITs are attractive to fixed income investors for a number of reasons, but one major one is that the sector offers incremental yield pick-up relative to other investment grade sectors.
In a higher-for-longer environment, we’ve seen yield-focused strategies proliferate, as investment grade investors, particularly long-only insurance funds, try to lock in above-average book yields for as long as possible. This dynamic has created enormous demand for 30-year paper and benefited “yield-ier” shorter-duration sectors, such as REITs.
Streeter: In a higher rate environment, while rates were going wider, one of our views was not to fight the Fed, and that's one reason why we went through a couple of years where we were pretty neutral on REIT credit performance. We love REIT credit over the long term because we strongly believe the companies are under-rated with the rating agencies given the great protections embedded in REIT public debt (real financials covenants which provide material downside protection).
Most of the property types we look at are actually doing very well from a top line perspective, and the noise has been around funding costs. So, investors during this period of rising rates were looking at other sectors that weren't as impacted. Now they're certainly very comfortable with where REITs are. We happen to have a more neutral opinion after being overweight for much of this year, because spreads have only been tighter in the investment grade market 4% of the time from where we are right now over the last two decades.
What do fixed income investors want in the current market?
McClure: Fixed income investors want to outperform their benchmarks and look to balance their desire for yield with the need to minimize credit loss.
Streeter: Some of the bonds in the most demand right now are Piedmont Office Realty Trust, Inc. (NYSE: PDM) bonds, which are at the wider end of the investment grade spectrum but are controlled by a handful of investors. Those are bonds we like. Piedmont is an office REIT focused on some of the southeastern markets, but we think the odds of them staying investment grade have actually gone up and those bonds are pretty yieldy right now relative to the rest of the investment grade space. It's very hard to find it, but investors want that story.
How is the current high-rate environment impacting how REITs are positioning themselves with fixed rate investors?
McClure: Many REITs are being more intentional in how they interact with the fixed income community. The Silicon Valley Bank debacle showed just how important having a quality bondholder base can be. When the market freezes up and spreads blow out, REITs need someone to sponsor them, someone to step in and backstop the credit. Not everyone has the luxury of tapping the market only when it is efficient to do so.
As banks whittle down CRE books industry-wide, bondholders increasingly will provide that marginal piece of capital, in my opinion. I believe many REITs appreciate this fact and have ramped up outreach as a result. Specifically, I’ve noticed several now produce a quarterly supplemental for fixed income investors, schedule quarterly calls with key bondholders, and/or host events exclusively for credit investors.
Streeter: It's all about spread investing, borrowing costs, and where you put that money to work and the yield you can generate. It's a question of which REITs have been playing defense and are moving to offense, or those that are playing offense and are continuing to play offense.
If you look at a REIT like Welltower Inc. (NYSE: WELL), they’ve been issuing converts, they’ve been issuing equity, and they're buying $5 billion plus worth of assets. Prologis, Inc. (NYSE: PLD) is another REIT where most of the levers that they're pulling are working right now in terms of their global development footprint and their mark to market.
The big question that we’re always asking ourselves when we meet with these management teams is, are they playing defense? Are they playing offense? Are they getting ready to pivot, and how are they going to make that pivot?
How important is it for REITs to cultivate relationships with fixed income investors and fund managers?
McClure: It is very important. First, there is a long-term advantage to having a loyal investor base that will stick with you throughout the cycle. Second, these are the people who have taken the time to learn the story and follow the credit. For context, there are approximately 60 corporate debt issuers in a sector that amounts to approximately 3% of the investment grade universe. The point being, there are a lot of REITs to choose from, investor bandwidth is a real constraint, and portfolio performance is not adversely affected by the decision to pass on a deal, so REITs should not take their bondholders for granted.
Streeter: We think it's very important. We used to go into the company suites and meet with management teams, but we’ve outgrown hotel suites (it got to the point where I would sit on the toilet seat in the hotel, the rooms were that crowded). At the last few REITweek conferences in June, we have had over 100 fixed income investors in a ballroom, and over three days we had over 30 management teams come and meet with them. We have a growing waiting list of REITs that want to meet with these fixed income investors.
There are a lot of rated REITs, and cultivating relationships with fixed income investors is increasingly important and something that many of them recognize as something they need to spend more time on. At the end of the day, cost of capital and having that dialog and transparency with fixed income investors is incredibly important for companies that are focused on spread investing.
There are a lot of rated REITs, and cultivating relationships with fixed income investors is increasingly important and something that many of them recognize as something they need to spend more time on.
How well do you think REITs do in terms of cultivating long-term partnerships with fixed income investors?
McClure: In general, most REITs do a very good job. The best REITs appreciate that there is a protocol or set of expectations about how a public bond issuer should behave, and the covenants help enforce that understanding.
Streeter: We’ve had some REITs that have had an on-again, off-again love affair with the fixed income market, and they've been opportunistic issuers. They've had a credit rating, but they haven't used it all that much. Maybe that credit rating has bounced around because they haven’t managed it as well as they should. Then during times of crisis, if the mortgage market isn't there, then they may want to come to the unsecured market, and maybe that market isn't as efficient for them as they would like.
We've had some REITs recognize that this is a multi-year investment in the relationship with fixed-income investors, because these are long-held assets, and you need to raise long-term debt. So, you want to invest the time now and build strong relationships for when you need it most.
Can you share any notable best practices or examples of REITs that have built successful strategies for engaging with fixed income investors?
McClure: I thought Kite Realty Group Trust (KRG) did a great job with investor outreach ahead of a planned debt financing. They had been out of the bond market for several years and knew their re-introduction would take some work, but they did the heavy lifting, hosting multiple investor meetings, and even a few dinners with credit investors in different cities to generate interest. Months later, when they ultimately decided to tap the market, their efforts were rewarded with a 10-times oversubscribed book and tighter pricing.
Streeter: There are several REITs that put together a fixed income supplement that they send to investors. Most REITs, but not all, disclose the actual covenant ratios on a quarterly basis in their supplemental package. That's something we've been encouraging for years. Some REITs go a step further. They schedule with me, or some of my competitors on the sell side, annual off-cycle Zoom meetings or in-person meetings just to show that outreach.