NEW YORK--()--With the fiscal cliff on the horizon, corporate entities issued record-breaking amounts of special dividends in December 2012 to take advantage of lower tax rates while continuing to exercise share repurchase plans.
REITs, on the other hand, have continued to avoid many shareholder-friendly activities. The primary driver has been REIT requirements to distribute at least 90% of taxable income as dividends. This inhibits REITs from accumulating large cash balances via free cash flow to pay special dividends or conduct share repurchases. Additionally, REIT bank covenants may restrain a REITs' ability to make certain restricted payments. Notable exceptions since 2006 include Equity Residential increasing leverage to repurchase $1.2 billion of shares in 2007, and AIMCO repurchasing nearly $800 million of shares in 2007-2008. Nonetheless, given these structural restrictions, Fitch does not expect sizable share repurchases or special dividends over the near-term.
Aside from these restrictions, REITs continue to maintain prudent financial policies and mostly conservative views on leverage, which Fitch expects to continue over the near-term. Many entities should continue to grow their portfolios on a leverage-neutral basis and issue sizable amounts of equity to finance acquisitions and development. This was evidenced by Equity Residential's $1.2 billion common equity issuance/continued asset sales to finance a substantial portion of its Archstone acquisition, and Digital Realty's ?716 million acquisition of the Sentrum portfolio, which was financed primarily with an approximately $830 million common equity offering.
The REIT structure also implicitly enhances management discipline with respect to capital allocation. Since REITs are unable to retain sizable amounts of cash flow, they are much more dependent on accessing the capital markets than standard corporate borrowers. As such, REITs essentially require tacit approval from investors to invest new capital in acquisitions and other growth opportunities, whereas standard corporate entities lack this implied market check.
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The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.