Higher leverage is a prerequisite for expansion
In order to fulfill the requirement of paying at least 90% of their taxable income to investors as dividends, REITs like General Growth Properties (GGP) opt for higher leverage to expand their real estate holdings. This increases their interest expenses, which could pressure their margins.
REITs require expansion in real estate holdings to create additional income sources. REIT managers work to maintain an optimal debt structure, which depends on how well the REIT converts its higher leverage to its advantage.
GGP’s consolidated debt in 2016 was $12.6 billion—lower than 2015’s debt level of $14.4 billion. Over the last five years, GGP’s total debt has decreased moderately from $20.6 billion in March 2011 to $18.4 billion on March 31, 2017.
General Growth Properties (GGP) reached a debt-to-equity ratio of 2.2x in 2014, its highest in the last five years. Since then, it fell to 1.8x in 2015 and ~1.5x in 2016. The company reported a debt-to-equity ratio of ~1.5x in 1Q17, which ended on March 31, 2017. The industry median debt-to-equity ratio is ~1.1x.
The chart above shows the trend of GGP’s debt-to-equity ratio for the past five years.
When compared to its peers, DDR Corporation (DDR) had the highest debt-to-equity ratio of ~1.6x. It was followed by Macerich Company (MAC) at ~1.2x and Kimco Realty (KIM) at 0.98x. GGP forms ~1.5% of the Vanguard REIT ETF (VNQ).
Reduced borrowing costs
GGP’s effective overall borrowing rate for fiscal 2016 was ~4.4%, close to its 2015 level of ~4.5%. GGP’s interest expenses fell $36.5 million due to the sale of properties at the Al Moana Center.
In the next part of this series, we’ll examine GGP’s valuation in comparison to its peers.