"The issuance of preferred stock can benefit real estate
investment trusts because of the instrument's equity-like features, such as
no fixed maturity date and subordination to debt liabilities, which are plusses
from a credit perspective," says Jay Siegel, a Moody's senior vice president
and author of a report released in July on REIT credit issues. "This is a substantial
benefit in managing liquidity and refunding risk."
At the same time, Siegel believes that while the upside benefits to REITs
of preferred stock issuance are considerable, the risks are also real. Issuing
preferred stock can increase an issuer's credit risk from both a balance sheet
and cash-flow perspective because this instrument ultimately possesses more
debt-like than equity-like features, says Moody's Investors Service in the report.
However, the report also notes that even a large amount of preferred stock in
a REIT's capital structure is not necessarily a negative factor if overall debt
levels are low enough. Consequently, the rating agency has not established guidelines
on the "proper" amount of preferred stock a REIT or other real estate firm should
use.
"A meaningful decline in a REIT's fixed-charge coverage due to issuance of
preferred stock can be a sufficient factor, in and of itself, to warrant rating
downgrades of outstanding debt and preferred securities," Siegel cautions.
According to Moody's, the downside risk of preferred stock is its impact on
effective leverage. Debt and preferred stock, therefore, should be looked at
together.
"We take this position because preferred stock dividends are fixed as to amount
and timing, unlike common stock dividends, which are more a function of earnings,"
says John J. Kriz, Moody's managing director for the real estate finance group.
"Moody's REIT ratings will continue to reflect this distinction."
When rating preferred stock, Moody's analysis focuses on the nature of the
instrument's payment terms, as well as on the legal and structural features
that tend to affect preferred stock ratings generally.
Significant structural issues that affect the ratings of REITs' preferred
stock can include legal subordination and the use of UPREIT structures. REIT
assets are often owned by an operating partnership affiliate, which is not directly
liable for preferred stock issued by its UPREIT parent. This structural subordination
can put stress on preferred stock ratings, particularly for weaker issuers.
On the upside, the report states that having access to diverse funding sources,
including preferred stock, is a positive rating factor for REITs, which rely
on external funds for growth. Preferred stock is a particularly good ‘match'
as a funding source for real estate assets, as it generally has a fixed stated
dividend rate and indefinite maturity.
