As a real estate investment trust (REIT), Brixmor, which claims to be the largest pure-play, open-air shopping center company in the United States with 520 such centers, must annually pay out at least 90% of its taxable income to shareholders in the form of dividends. Since it can’t pocket much cash, continually raising new capital is the key to funding its operations and its ongoing investments in real estate.
Brixmor, which went public in October 2013, uses both debt and equity financing for that purpose, and bringing in new capital investors is vital to its viability as well. But the more investors it attracts, the more profits it needs to generate in order to provide them with acceptable returns. That means steady growth is imperative.
The KISS principle, first noted by the U.S. Navy in 1960, states that most systems work best if they are kept simple rather than made complicated. Brixmor doesn’t invoke the acronym itself, but it seems to take the principle to heart, positioning the simplicity of its business model and strategy as a centerpiece of its appeal to investors.
Michael Pappagallo, Brixmor’s finance chief, recently spoke with CFO about that model, the company’s financing activities and growth efforts, and the challenges that CFOs in the REIT industry face. An edited version of the discussion follows.
There are a lot of REITs. What is unique about Brixmor that could get investors’ attention?
First, our portfolio consists of wholly owned properties, is domestic only, and is composed of a single asset class: community and neighborhood shopping centers. Investors value simplicity. Having a single asset class, for example, enables them to better understand our growth drivers and assess growth opportunities without a lot of uncertainties.
Second, we have a simple, straightforward business strategy: to leverage our national grocery-anchored platform and strong retailer relationships to deliver sustainable organic growth and maximize the value of our portfolio.
Third, we have a clear plan and commitment to improving our capital structure and strengthening our balance sheet. We have approximately $2 billion of primarily secured mortgage debt coming due over the next two and a half years, and we will seek to replace it with a combination of bonds, bank debt, and potentially preferred stock.
What will that do for you?
It will lower our cost of capital. Between now and the end of 2016, the average interest rate on our maturing debt is 5.6%. So notwithstanding the recent increase in Treasuries and some uncertainty in the bond market, we still believe there is ample room for us to have a positive interest arbitrage by replacing existing maturities of secured debt with unsecured debt at lower rates and with maturities between five and ten years.
That in turn will improve our unencumbered asset base. Properties that are free of a mortgage are able to contribute more operating income. We have already increased our unencumbered asset pool from 40% of our properties at the end of 2013 to about 60% now, and the [share of] total operating income [derived] from unencumbered properties will rise from 52% now to 80% by the end of 2016.
How much debt are you carrying?
About $6 billion, compared with $9 billion at the time Blackstone bought us in 2011.
The process of improving our capital structure and strengthening our balance sheet began in earnest in 2013. That July, four months before our IPO, we completed a $2.75 billion unsecured credit facility, consisting of a $1.5 billion term loan and a $1.25 billion revolving credit facility, with a consortium of top-tier financial institutions. It enabled us to repay $2.4 billion of secured debt.
We then deployed the [$825 million] proceeds of our IPO exclusively to further reduce debt and bring our key leverage statistics into an acceptable range with our REIT shopping center peers.
In early 2014, we added another bank facility and began an aggressive engagement with the three major rating agencies to establish a road map for getting investment-grade ratings. We got them late last year from all three, which allowed us to access the capital markets rather than just the bank markets. We followed up in this year’s first quarter with our inaugural bond offering, raising $700 million of 10-year unsecured debt at an attractive interest rate.
Aren’t these kinds of financing steps typical of what most REITs do?
Yes, actions such as securing a revolving credit facility and accessing the bond market are common financing tactics employed by REITs. What was unique was how quickly we managed the evolution of our capital structure — the timing, the aggressive yet methodical approach, and the degree and extent of outreach and communication to the investment community.
What are some of the nuances of being CFO of a REIT?
The REIT industry is covered extensively by the investment research community. One could argue that the number of sell-side research shops covering REITS is well out of proportion to the industry’s market capitalization. There is an ongoing demand for detailed, granular guidance on earnings expectations and operating performance statistics, and notice is taken of even slight differences. So careful communication of expectations, and changes in them, is required.
Also, real estate is a long-term asset, and creation of value takes time. We must pay a significant amount of our earnings in dividends, but balancing the right level of dividend to be market-competitive yet allocating capital to longer-term growth is critical. Sometimes you have to take an unpopular action, like not increasing the dividend or reducing a planned increase. While any business can face the tradeoff between long-term value and short-term earnings and dividend growth, it is particularly challenging for REITs.
Finally, a REIT’s assets can be valued with relative ease, and as a result, the difference between the “private market” valuation of a company and its trading price can be readily determined. REIT CFOs need to be mindful of using equity currency accretively, and generally issue equity only when the stock value is trading at a premium to the private valuation. Because of the transparency of valuation, it is clear to investors when stock is being issued below net asset value, and the consequences can be painful.
Was that a big factor in the timing of your IPO?
Yes. A REIT’s management needs to work with financial advisors to determine if the portfolio is worth more on the private market or the public market.
The overall growth of REITs in the investment universe has been impressive, yet they are still often tarred as “different” from other types of stocks. That presents another challenge for REIT CFOs: expanding the universe of generalist investors who may not be attuned to some of the nuances in the metrics of REIT earnings and valuations. The pending establishment of a separate [Global Industry Classification Standard] for real estate and moving out of the financial sector in 2016 should be helpful for that cause.
How competitive is the REIT industry?
While consolidation is inevitable in every industry, the REIT industry seems to be putting up a good fight by actually increasing the number of REIT vehicles. The shopping center sector in particular has seen growth, with a number of smaller companies being created. There are now more than 20 shopping center companies.
Retailers and restaurant companies spinning off their owned real estate into REIT vehicles is also back in vogue. This happened recently with Sears. Operating companies generally don’t receive credit from the market for their real estate, so the rationale is that the market will value a company more highly as two entities.
Conversely, investors are increasingly placing a premium on liquidity, so larger sizes — whether equity trading volumes or the size of bond issuances — will be increasingly important. Investors want the ability to trade in and out of companies when they choose, and if there are not an adequate number of buyers and sellers of a security it can limit an investor’s flexibility.
This poses a challenge to smaller REITs in terms of optimal execution when accessing the capital markets. It also raises an issue as to whether private investment funds are poised to effectuate the privatization of smaller companies in the current environment.