Probably a dumb question.
As I understand, a REIT must return 90% of its taxable net income to shareholders every year. Interest is tax deductible, so all cash flow is available for interest payments. But how does a REIT ever generate enough free cash (after required dividends) to meaningfully pay down loan principal?
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We close our deals in all cash - no financing.
i.e. no asset-level debt — all fund-level, so issuing additional equity to pay down principal etc.
Omg...delet this nephew.
Because REITS distribute 90% of taxable net income to share holders, they do not pay corp tax. Therefore no advantage to using debt for them (which would reduce taxable income).
Nowadays most Reits take unsecured financing which have interest only payments. Not sure how amortization is treated in Reit distribution structures for Reits that are too small to take unsecured debt.
Handful of things here: [Edit: should have noted that most of the below applies to your standard mid/large cap public REIT. YMMV as far as secured debt with small cap and private REITs but basic concepts remain true] - REITs need to distribute 90% of taxable income, key word being taxable, meaning their distributions should not represent 90% of their actual cash flow (depreciation being the main driver in this delta). Look at some public REITs AFFO payout ratios for illustration of this. That being said - situation dependent on whether or not REIT will use this excess CF to repay principal on debt. - Assuming you are talking about a normal amortizing loan, most public REITs shy away from using secured debt. To the extent they have amortizing mortgages on their properties, see above. - If you are just wondering how a REIT repays existing unsecured debt - they issue additional debt or equity and can use the proceeds to pay down debt. As someone alluded to above, REITs generally fund growth (acquisitions and development) through an unsecured line of credit. For various reasons it's favorable to have capacity on your line so in a normal environment the REIT will regularly issue long term debt or equity to pay down their line of credit.
Thanks, really helpful. +SB
Point well taken on the difference between income and cash flow. Fair to assume REITs typically have depreciation well in excess of maintenanc capex, such that reported income consistently understates cash flows?
My general question was from the perspective of a commercial cash flow lender. Regardless of the type of debt a REIT uses, how do they ever go about de-levering with such significant cash obligations to its shareholders? I think you've ultimately confirmed my assumptions that typical sources of repayment are refinancing or asset sales, and I shouldn't expect excess cash flow after required dividends to be sufficient by itself.
The source of repayment is refinance. Public REITs typically have unsecured credit facilities which are supported by an Unencumbered Asset Pool (UAP). The lender will have leverage, fixed charge, net worth, interest coverage, etc. covenants.
EDIT: nvm this is dumb
Question related to the answers above.
It sounds like the primary answer to OP's question is that they have to rely on refinancing. Doesn't this substantially increase the cost of debt? Do REITs typically have high cost of debt because they can't pay down loan principal as fast as a non-REIT borrower?
It really isn't that heavily reliant on refinancing.
We're just discussing the difference between corporate finance and secured borrowing. Corporations maintain their leverage because it improves their returns, but could delever if they wanted to.
Lenders heavily structure these credit facilities.
Lenders size the credit facilities based on the value and cash flow of large real estate portfolios. These are heavily structured, unsecured, credit facilities that are supported by a pool of unencumbered assets. The loans are structured with similar covenants as other large corporate debt facilities are structured.
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