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Analyst Says REITs’ Capital Structures Appropriately Leveraged

04/29/2014 | By Allen Kenney

Luke Zubrod, director of risk and regulatory advisory services with Chatham Financial, joined REIT.com for a video interview during REITWise 2014: NAREIT’s Law, Accounting and Finance Conference held in Boca Raton, Fla.

Zubrod was asked about the dialogue surrounding the appropriate level of leverage for REITs and the stakes related to the decisions that REITs make regarding their interest rate exposure.

“REITs as an industry pay close attention to interest rate risk, and that’s true of any industry that has a predominance of investment in physical assets, industries that tend to be more mature, companies that tend to be more mature,” Zubrod said. “Take that in contrast to industries that are involved in professional services or have intangible products or are less mature as an industry—say, technology start-ups, for example. You don’t have nearly as many interest rate risk conversations with companies like that. That’s generally because they have much less leverage. Because REITs fit in that former category of physical assets and higher maturity, it supports more debt generally and interest rate risk becomes important for anyone with higher leverage.”

Zubrod also discussed the right mix of fixed- and floating-rate debt that should be held on REITs’ balance sheets.

“The way that we can analyze if someone is exposed to short-term interest rate risk is to look at the percentage of fixed-rate debt compared to the percentage of floating-rate debt that a company has,” he said. “REITs as an industry are generally very well positioned and generally conservative in skewing towards fixed-rate debt. If we look at REITs, there’s really a range between about 75 percent fixed-rate debt to 95 percent fixed-rate debt. The average REIT really falls right about in the middle of that range, about 84 percent. If there were a severe shock to short-term interest rates, it would not be an extraordinary burden on REITs from the perspective of risk. The less obvious and more important risk to REITs is their exposure to long-term interest rates. REITs are buy-and-hold investors, which really permits them to enter into long-term fixed-rate debt.”