Higher leverage essential for expansion
As we discussed previously in this series, REITs like Simon Property Group (SPG) have to pay at least 90% of taxable income to investors as dividends. Higher dividend payout by many REITs forces their managements to go for higher leverage to expand real estate holdings, which results in higher interest outgo, thereby reducing the company’s earnings.
On the other hand, expansion in real estate holdings creates additional sources of income for leveraged REITs. And so how good a company’s management is will affect how well it converts higher leverages to its advantage.
As of the end of fiscal 2014, Simon Property’s consolidated mortgages and unsecured indebtedness declined by 8% from the previous year to $20.8 billion. The company’s total debt peaked to $22.7 billion in 2013.
Debt-to-equity ratio highest among its peers
Simon Property’s DE (debt-to-equity) ratio reached a high of 4.8 in 2008. Since then, its DE ratio has been declining due to its debt-reduction initiatives. However, since 2009, the company’s DE ratio has increased consistently, reaching a high of 3.49 in 2014—the highest debt equity ratio in its peer group, after Taubman Centers (TCO), whose DE ratio was 4.82.
Macerich (MAC), one of the close competitors of Simon Property, had the lowest DE ratio in 2014, at 1.04.
Reduced borrowing cost
Simon Property’s maintained an effective overall borrowing rate on its debt for fiscal 2014—4.41%, compared to 4.80% in 2013. This reduction was primarily due to a decrease in the effective overall borrowing rate, on a fixed rate debt of 38 basis points, combined with a decrease in the effective overall borrowing rate, on a variable rate debt of 6 basis points. The weighted average years to maturity for its debt was 6.2 years, compared to 4.2 years in 2013.
Over the last four years, Simon Property has reduced the weighted average interest rate on its debt portfolio to 4.4% at the end of 2014 from 5.43%in 2010.
Investors looking for exposure in commercial real estate can invest in REIT ETFs. Simon Property Group (SPG) and Public Storage (PSA) make up 8.16% and 4.06% of the Vanguard REIT ETF (VNQ), respectively. Equity Residential (EQR) comprised 6.70% of the iShares Cohen & Steers REIT ETF (ICF).
In the next part of this series, we’ll analyze Simon Property’s valuation.