Keeping your a$$ out of the fire: Debt lessons from REIT land
---- How to manage a REIT ----
Ten years ago, Green Street published a report that said two skills differentiate REIT managers.
Skill 1: Capital allocation
When you have access to cheap capital, grow. When your capital is expensive, use property sale proceeds to buy back shares/debt.
Skill 2: Balance sheet management
Leverage cuts both ways. More debt sometimes improves returns but always increases risk.
"Simple, low-leverage business models" with cost-of-capital driven capital allocation strategies "are virtually assured of adding value above and beyond that generated by their real estate portfolios."
These lessons continue to play out over various parts of the cycle, yet they remain largely misunderstood or ignored.
---- MAC: Real-time case study ----
Macerich is a big mall owner but has underperformed significantly over the last decade. i.e., down 3x more than its larger peer, Simon Properties.
While other mall REITs trade at 5% NAV premiums, Macerich trades 30% below NAV.
The big difference: Debt-to-EBITDA ("leverage")
Other mall owners = 5-6x
Macerich = 9x
Macerich brought in a turnaround CEO earlier this year, who just released his turnaround plan, which boils down to...
1. Issuing equity
2. Selling and giving back properties to lenders
3. Growing NOI by investing in its strongest centers and development
[Issuing equity is particularly painful, since MAC trades at such a big discount. It's hard to outperform your peers when your equity is significantly more expensive.]
---- A few thoughts ----
-- More debt typically doesn't solve a debt problem, which explains why borrowing isn't a part of MAC's turnaround plan.
-- Ripping off the bandaid is a must, which typically revolves around simplification and less debt.
-- Since income growth is the only way out, cutting the chord on low-growth properties is necessary.
---- Why does this matter? ----
Jackson Hsieh (MAC's new CEO) got a $10-15M pay package to dive into the Macerich seat, with significant incentives to turn the ship around. Can he do it? It's definitely possible (see CUZ's turnaround as an example).
You may not be a REIT CEO, but Green Street's focus on capital allocation applies to all real estate players.
...which is why mortgages, debt, and leverage take center stage this week in the current FastTrack cohort.
We argue that valuation is the most important skill in real estate but that understanding the causes and effects of leverage is what keeps investors in or out of trouble when sh*t hits the fan.
Macerich is a decent example of how leverage cuts both ways.
PS - Hsieh is presenting more details on his turnaround plan later this morning at NAREIT's REIT Week (see link on MAC's investor relations page if you're interested).
Read the full case study here!
COMMENTS