How are REITs' debts structured, are they at healthy levels?

This is the 3rd edition of the initial series of the Global REITs newsletter. This series focus on bringing you interesting facts about this asset class, divided into 8 topics. As they are time-sensitive, I chose first write about these 8 topics that can help investors like you better navigate the current risk-return realizations.

After the 8th edition, we will take a closer look at the general characteristics of REITs, the main countries, strategies, and portfolio composition. The idea is to present each content on two levels: the first a lighter, easy to read content like this one, and the second delving deeper into the same content, but more technical and practical with methods, algorithms, and investment processes using Python as the programming language.

For those who haven't read editions one and two, I leave the links below. In the first, we talked about the relationship between REITs and direct real estate investments (private real estate).

The theme continues in the second edition, also covering the current price levels of REITs and their connection to the stock market.

Let's move on to the current topic, debt. How are REITs' debts structured, are they at healthy levels?

The debt structure of REITs (Real Estate Investment Trusts) has undergone significant improvements, especially considering the context of interest rate fluctuations and changes in the global economic environment.

Analyzing the trajectory of the debt-to-market value ratio, debt composition, and the nature of interest rates applied to REITs' debts, we can see a more cautious and strategic approach taking by REITs in managing their financial obligations. Let's detail these aspects:

1. Significant Reduction in Leverage

The following graph shows the evolution of debt-to-market value ratio. REITs' leverage has dropped from about 65% at the end of 2008 to approximately 35% in 2022. This reduction in leverage indicates more conservative debt management, aiming to mitigate the risks associated with indebtedness in a rising interest rate environment.

2. The concentration is on unsecured debt

There has been an steady increase in the proportion of unsecured debt, from about 50% to approximately 80% by the end of 2022. The transition to a higher proportion of unsecured debt offers REITs additional flexibility in managing their assets, not needing to sell them to cover the debt collateral difference, allowing for more efficient resource reallocation and portfolio optimization.

3. Predominance of Fixed Interest Rates

About 91% of REITs' debt is now tied to fixed interest rates, an increase from approximately 80% observed in 2008. The preference for fixed-rate debt provides greater predictability of cash flows, essential for REIT operations that depend on generating stable and predictable cash flows from rents and other real estate activities.

Conclusion

The debt structure of REITs reflects prudent and strategic financial management, adapted to face challenges such as rising interest rates. The reduction in leverage, the evolution towards a higher proportion of unsecured debt, and the predominance of fixed interest rates indicate an approach focused on financial stability and the ability to adapt to different economic scenarios. These characteristics are fundamental to sustaining the financial health of REITs and their ability to generate consistent returns for investors, especially in periods of economic uncertainty.

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