In this prolonged higher rate environment, we have seen yield-focused strategies grow rapidly as investment grade investors, particularly long-only insurance funds, attempt to lock in above-average book yields for as long as possible. This dynamic has created huge demand for 30-year paper and benefited sectors with shorter “yield-year” durations such as REITs.
Streeter: In a high rate environment, when rates were widening, one of our thoughts was not to fight the Fed, and that’s one of the reasons we were pretty neutral on REIT credit performance for a couple of years. We like REIT credit over the long term because we firmly believe that companies are undervalued by the rating agencies, given the great protections inherent in REIT public debt (real financial contracts that provide material downside protection).
Most of the property types we look at have been performing very well from a top line perspective, and the noise has been around funding costs. So, in this period of rising rates, investors were looking at other sectors that weren’t as affected. They’re certainly very comfortable with the state of REITs now. Our view is more neutral after being overweight for most of this year, as spreads in the investment grade market have only been this low 4% of the time over the last two decades, which is where we are now.
What do fixed income investors want in the current market?
mcclureFixed income investors seek to outperform their benchmarks and balance their desire for profit with the need to minimize loan losses.
StreeterThe following are the bonds that are most in demand at the moment: Piedmont Office Realty Trust, Inc.. (NYSE:PDM) bonds, which are on the broad end of the investment grade spectrum but controlled by a handful of investors. Those are the bonds we like. Piedmont is an office REIT that’s focused on certain southeastern markets, but we think their chances of remaining in investment grade have really increased and those bonds are pretty high yielding relative to the rest of the investment grade space right now. It’s very hard to find, but investors want that story.
How is the current high rate environment affecting REITs’ position with fixed rate investors?
McClure: Many REITs are being more deliberate in how they interact with the fixed income community. The Silicon Valley Bank debacle showed how important having a quality bondholder base can be. When the market takes a downturn and spreads get squeezed, REITs need someone to sponsor them, someone to step in and lend credit back. Not everyone has the luxury of tapping the market when it’s efficient to do so.
As banks reduce industry-wide CRE books, bondholders will increasingly provide that modest share of capital, in my opinion. I believe many REITs appreciate this fact and have increased outreach as a result. In particular, I have noticed that many now prepare quarterly supplements for fixed income investors, schedule quarterly calls with major bondholders, and/or hold events specifically for credit investors.
Streeter: It’s all about spread investing, cost of borrowing, and where you put that money to work and how much profit you can make. It’s a question of which REITs are playing defensive and getting aggressive, or the ones that are playing aggressive and continuing to play aggressive.
If you look at REITs this way Welltower Inc(NYSE: WELL), they’re issuing converts, they’re issuing equity, and they’re buying over $5 billion worth of assets. Prologis, Inc. (NYSE:PLD) is another REIT where most of the levers they’re pulling are working right now in terms of their global development footprint and their mark to market.
When we meet with these management teams, we always ask ourselves the big question: are they playing the defensive game? Are they playing the offensive game? Are they getting ready to make a change, and how are they going to make that change?
How important is it for REITs to develop relationships with fixed income investors and fund managers?
mcclure: This is very important. First, there is a long-term benefit to having a loyal investor base that will stay with you throughout the cycle. Second, these are people who have taken the time to learn the story and follow the credit. For reference, there are about 60 corporate debt issuers in one sector which is about 3% of the investment grade universe. The point is that there are so many REITs to choose from, investor bandwidth is a real constraint, and the decision to pass on a deal does not necessarily have an adverse effect on portfolio performance, so REITs should not take their bondholders lightly.
Streeter: We think this is very important. We used to go to company suites and meet management teams, but now we’ve moved beyond hotel suites (it got to the point that I would sit on toilet seats in hotels, the rooms were so crowded). At the last few REITweek conferences in June, we had over 100 fixed income investors in one 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 these fixed income investors.
There are so many rated REITs, and developing relationships with fixed income investors is becoming increasingly important and many of them recognize that they need to spend more time on it. At the end of the day, cost of capital and having dialogue and transparency with fixed income investors is incredibly important for companies that are focused on spread investing.
