In Closing
My letter to REIT CEOs
by Ralph Block
D
ear Mr. or Ms. CEO:
You have carefully re-
viewed the prospects for
the industry and capital
markets for 2009 with
your board of directors, and cer-
tainly don’t need any suggestions
from an outsider. But I have fol-
lowed REITs for decades and,
as most of my life’s savings are
invested in them, I have plenty
of skin in the game. So perhaps
you’d be kind enough to give me
just a few minutes.
It’s obvious that REITs are facing numerous head-winds, ranging from higher vacancy rates and
tenant bankruptcies to rising cap
rates and spooked lenders who
won’t readily part with their (or
even the government’s) money.
The current crunch will abate
eventually, but credit will remain
tight for some time.
It’s also obvious that, in
this environment, the first
order of business for 2009 is to
s trengthen the balance sheet.
I nvestors are right to focus on
r isk, and a weak balance sheet
n otonlyputspressure on a
R EIT”s stock price. It creates a
s cenario where outcomes can
r un from bad to horrible.
A ccordingly, over the near-
t erm, capital allocation deci-
s ions will have to be driven by
b alance sheet and liquidity
needs and will often require
tough decisions. Much of your
free cash flow may have to be
used to reduce debt, and you
may even want to sell a few assets, even at less than optimal
prices. Developments will have
to be postponed, return hurdles
raised, and pursuit costs written
off. And, particularly as nobody
knows the trajectory of cap rates
over the next few months, near-term acquisition opportunities
should have a low priority. Stock
(and perhaps even debt) repurchases should, in most cases, be
shelved; boosting liquidity is a
greater priority. Although acquisitions and stock repurchases
may boost funds from operations, that isn’t what investors
will be focusing on.
Please don’t ignore the possible need to cut the dividend, as
painful as that would be. To the
extent your balance sheet is vulnerable, a cut will increase funds
available for debt reduction; the
prior dividend can be reinstated
when space and capital markets
improve. Building financial
strength will be rewarded, not
criticized, by investors.
But it’s not enough to play
only defense. A year from now,
splendid external growth opportunities will begin to open
up to well-capitalized REIT organizations; it’s not too early to
be thinking offense. Acquisition
prospects will be abundant in
2010 and 2011, as underwater
property loans placed at high
loan-to-value ratios come due.
The real estate markets eventually will look better also, as new
supply will decline just as the
U.S. economy begins to recover
from the recession. REITs capable of creating value and “
grave-dancing” will be rewarded by
investors.
Operationally, focus on those
issues at least partially within
your control, including operating costs and overhead. Recognizing market realities, be flexible on rates when leases expire.
Finally, communication with
your shareholders is more important than ever. They want
to know how you are running
your business in this challenging
period, and how your company
will survive this “perfect storm.”
Let them know that the REIT
is well-positioned defensively,
but that it also has a strategy,
and the resources, for playing
offense when the time is right.
Commercial real estate has
always been cyclical, but sound
REIT organizations have been
able to withstand the occasional
head-winds created by weak
markets and very tight credit
conditions. Conservation of resources and a sound game plan,
when well executed, will prepare
us for better times. Thanks for
listening. ✦
BRIAN DAVIS
