As we know all too well, REITs and REOCs have just completed two very tough years. The public equity and debt markets have been very tight and our stocks have generally traded at significant discounts to net asset value. Although most companies have posted increased earnings due to strong internal growth in operating income, development, and new revenue sources, as a result of the capital markets, many companies have looked for alternative capital sources such as joint ventures (JVs), secured debt, and perpetual preferred stock/units. In addition, a greater number of companies have looked to stock repurchase programs as a way to boost per share earnings growth. All of these recent developments have caught the attention of the credit rating agencies.

Not Created Equal

Last November, I had the pleasure of leading the "What's Hot in Credit Ratings" panel at NAREIT's CFO Workshop. The panelists included representatives from all of the major rating agencies: Leisa Bates, vice president/senior analyst, Moody's; Lisa Sarajian, director, structured finance, Standard & Poors; Mark Berry, assistant vice president, Duff & Phelps; and John Olert, senior director, Fitch IBCA. The panel discussed the use of JVs, preferred securities, and stock buybacks, as well as the general outlook for the industry.

During the panel's discussion of JVs, there was agreement that these arrangements represented a good capital source for REITs, but that not all JVs are created equal. A concern was expressed about exit strategies, especially those that allow the JV partner to "put" their interest to the REIT. The panelist were split on how they treat JV's for rating purposes, with some using 100 percent consolidation and others using proportional consolidation. All of the panelists encouraged enhanced disclosure of both on-balance sheet and off-balance sheet joint ventures.

Similar to JV's, the panelists agreed that perpetual preferred stock and units represent an appropriate source of capital for REITs, but that at some point bondholders should become concerned with companies that have pushed the limit on the issuance of preferred securities.

The panelists generally agreed that stock buybacks are acceptable as long as companies don't increase leverage to buyback shares. Some panelists pointed out that although buyback programs are commonplace in the rest of corporate America, REITs should be viewed differently because they are dependent on equity for growth, whereas other companies can use retained earnings.

Keeping in Balance

The overall theme that emerged from the discussion was how rated companies should balance the interests of their shareholders and bondholders in this capital constrained environment. Although none of the panelists was overly concerned with the impact of joint ventures, preferred equity issuances or stock buybacks when viewed singularly, they were concerned that these trends were leading to a possible deterioration in the overall credit quality of some companies. Panelists generally felt that there was going to be more differentiation between companies in 2000, with the prediction of more downgrades than upgrades. Companies that focus on managing their properties and their balance sheet appropriately would enjoy access to capital, while others would have difficulty.