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.
