As real estate investment trusts embark on an acquisition tear, banks are expected to make more unsecured loans to help finance them.
Last week, Chase Manhattan Corp. agreed to make a $3 billion, two-year loan to Simon DeBartolo Group Inc. to help finance the REIT's planned $5.78 billion acquisition of Corporate Property Investors.
Chase plans to fully underwrite the loan, which is the biggest-ever to a shopping mall REIT.
Commitments like the Chase loan are expected to become more common as REITs increasingly look to acquisitions for growth.
Many REITs that once relied on the public equity markets to fuel their expansion are now finding mergers a much more cost-effective alternative. And banks are more than willing to help REITs fund their acquisitions.
That scenario has some market observers wondering what will happen to those loans if a downturn in property values occurs.
If REITs are not able to tap the public markets, their ability to repay their loans would be impaired.
"When the market turns and REITs are no longer producing what they are and can't go to the public markets, they will be forced to borrow even more," said Joel Reck, an attorney at Brown, Rudnick, Freed & Gesmer, Boston. "But banks will already be hurting because of too much exposure to real estate, and credit will tighten."
Lending to REITs is already big business for banks. Last year, banks made a record $10.5 billion of unsecured loans to REITs, according to the National Association of Real Estate Investment Trusts.
Just last month, BT Alex. Brown Inc. and Chase Manhattan Corp. wrapped up a $ billion loan to Starwood's Hotel and Resorts Trust, backing its $13.7 billion acquisition of ITT Corp., which was announced last October.
More REIT deals are expected. Because smaller REITs lack economies of scale, diverse assets, and other benefits of size, they are having difficulty tapping the public markets for cash. That is sending them into the arms of larger entities, fueling a REIT merger and acquisition boom.
"To go public, you need probably a minimum of $800 million of assets, and there's not a lot of critical mass left," said Louis Taylor, an analyst at Prudential Securities Inc.
Added Lisa Sarajian, a director at Standard & Poor's: "Private entities that considered going public couldn't get the desired pricing from an IPO, or got better pricing than expected in the private markets."
At the same time, "debt financing is so attractive that many companies we're following are starting to pressure their leverage ratios," she said.
Unsecured loans to REITs are typically made on the basis of the investment-grade credit ratings that these companies have achieved. Pricing on Chase's loan to DeBartolo, for example, will be based on a matrix tied to the company's credit rating.
Fitch IBCA Inc. and Moody's Investors Service each put DeBartolo's $1.2 billion of debt and preferred stock on ratings watch with negative implications when its deal for Corporate Property was announced.
Fitch reasoned that the "magnitude and actual financing of the company's more recent transactions ... have pushed these levels beyond what Fitch IBCA believes is consistent with the company's past financial and potentially the current rating level."
Bankers reason that REITs are safe borrowers because their risks are spread over large and diverse portfolios of properties. And their debt-to- asset-value ratios are typically less than 50%.
"There is a much more appropriate allocation of risk," said Jon Zehner, head of real estate investment banking at J.P. Morgan & Co. "Corporate real estate lending is being done appropriately this time in the cycle, and we will not see the damage to banks that has been done previously."
Lenders and other market watchers say Chase will have no problem syndicating the DeBartolo loan-though the REIT is leveraged at 55%, which is a bit higher than other REITs.
The company's investment-grade credit rating virtually guarantees it will be able to replace its interim credit with long-term capital obtained through the public debt, equity, or preferred stock markets.
"For an interim lender, the likelihood of getting the credit line paid back is relatively high," said Mr. Taylor of Prudential Securities.
Also in Simon DeBartolo's favor is the significant leverage it has over tenants in its shopping malls. If a retailer wants to enter a new market, the REIT can offer it more location options.
"Lending to REITs is getting more credibility than in the past," said Mr. Zehner. "Clearly the lending community-not just the banks-are getting much more comfortable with real estate corporate customers."
"The REIT market is an aberration against the way that real estate investment has been done in the past," said Gary Levine, a REIT analyst at Josephthal, Lyons & Ross. "The fact that these companies are so low- leveraged gives them a lot of elasticity as to what to do when times change."
At the same time, this generation of REITs has not seen a cyclical downturn.
"We haven't seen the full cycle yet, and we don't know whether or not everything that we've been saying is good about REITs stays good and creates a much smaller cycle," said Christopher Hartung, a REIT analyst at NationsBanc Montgomery Securities Inc. "If it has, then the volatility of a real estate asset class has diminished."
