Share Buybacks Pose Risks for REITs

NEW YORK CITY—More share buybacks are in the offing for US REITs, Fitch Ratings said Tuesday. However, although stock repurchases may look appealing to REITs, the ratings agency is taking a negative view of such buybacks.

“Share repurchases may be a plus for REIT net asset values in the short-term, but over time the resultant increase in leverage could impair credit quality,' says Reinor Bazarewski, a director with Fitch. “It's important to note that current REIT leverage is above levels seen at the end of 2006, just before share buybacks spiked sharply during the last credit cycle.”

It's the leverage-increasing aspect of share buybacks that causes Fitch to take a dim view of them. Even so, a new report acknowledges their appeal to equity REITs.

“REIT equity prices traded at a 7.2% discount to NAV at Dec. 31, 2013 compared to flat at Dec. 31, 2012 and a 3.1% discount at Dec. 31, 2011,” the report states. “REIT stocks outperformed broader indices during first-quarter 2014; however, trading levels continue to remain below NAV and make share repurchases an intriguing use of capital.”

Such repurchases can only grow so larger, however: Fitch notes that the REIT structure restricts share buybacks, in view of the limited ability REITs have to retain cash flows. Fitch says it expects these structural considerations to limit large stock repurchases over the longer term. Furthermore, Bazarewski says, “The severe economic downturn and subsequent dilution via en masse deleveraging may also have permanently changed the mindsets of REIT managements to maintain greater fiscal responsibility.”

Among property types, REITs in the data center and multifamily sectors are most likely to implement share buybacks. The report notes that data center REITs traded at an average 12.5% discount to NAV as of Dec. 31, and the sector is also the lowest levered with 3.5x debt/recurring EBITDA.

In the apartment sector, REITs have continued trading at a “meaningful” NAV discount given decelerating SSNOI growth, elevated supply in several markets and uncertainty about the fate of Fannie Mae and Freddie Mac. Apartment REITs bought back $37 million of stock last year, up from an average of $13 million per year between 2010 and 2012.