Higher leverage essential for expansion
As mentioned earlier, REITs such as American Campus Communities have to pay at least 90% of taxable income to investors as dividends. Higher dividend payout by many REITs forces management to go for higher leverage to expand real estate holdings. This results in higher interest outgo, thereby reducing earnings. On the other hand, expansion in real estate holdings creates additional sources of income for leveraged REITs. The point is how good management is in converting higher leverage to its advantage.
As of the end of fiscal 2014, American Campus Communities’ (ACC) consolidated debt was $3 billion, up by 8.3% over the previous year. Over the last five years, ACC’s total debt has experienced a substantial rise. The company’s total debt rose from $1.3 billion in 2010 to $2.9 billion as of September 2015.
Debt to equity
American Campus Communities’ (ACC) debt-to-equity ratio remained at a comfortable level during the past five years. It reached its high of 1.1 in 2010. Since then, it has declined consistently to reach a low of 0.81 in 2012, although it rose to 1.1 in 2014. As of September 2015, ACC’s debt-to-equity ratio at 1 is lower than the industry average of 1.1.
Peer group comparison shows that American Campus Communities’ debt to equity is on the lower side. Apartment Investment & Management Company (AIV) has the highest debt-to-equity ratio in the peer group at 2, followed by UDR (UDR) at 1.13 and Equity Residential (EQR) at 0.96. The iShares US Real Estate ETF (IYR) invests 0.53% of its portfolio in American Campus Communities.
Higher share of fixed rate-debt
As of the end of fiscal 2014, 81% of ACC’s leverage consisted of fixed rate debt, while 19% comprised variable rate debt. The weighted average maturity of fixed rate debt was 5.5 years with a weighted average interest rate of 3.9%. On the other hand, the weighted average maturity of variable rate debt was 3.3 years with a weighted average interest rate of 1.7%.
Most other apartment REITs have much higher proportions of fixed-rate debt. The higher percentage of fixed-rate debt provides ACC a hedge against a rise in interest rates, capitalization rates, and inflation.
In the next part of this series, we’ll analyze American Campus Communities’ valuation.