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Playbook for REIT extension trades and barbell strategies

admin | September 18, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

REITs have seen considerable activity in the primary markets throughout the past several months. A brief pause provides a chance to reconcile some of those exposures and determine how best to allocate risk and duration. Although the current curve for the REIT sector is not materially steeper than the broader overall market, a detailed roll analysis identifies the best strategies for investors potentially looking to extend duration, or target the most efficient parts of the curve among individual issuers or subgroups within the segment.

Last month, we took a close look at the Insurance sector for potential opportunities to take advantage of the steep spread curve versus the broader IG corporate bond market (APS Strategy: Extend/Barbell in Insurance). This week we apply that process to the REITs sector (Exhibit 1).

Exhibit 1: Broad Investment Grade (Blue) vs BBB-Rated REITs (Red) spread curves

Source: Bloomberg – IG Corporate and Insurance (A) Fair Value Curves

A roll analysis by issuer

The roll study provides a playbook for determining which issuer curves provide the biggest incentive to: extend duration; pursue a barbell strategy in order to mitigate the overall impact to portfolio duration; or stay in the 10-year bucket.

An extensive roll analysis of IG REIT issuers (Exhibit 2) with outstanding benchmark issues in the 5-year, 10-year and 30-year maturity buckets shows the available spread pick to move from each issuer’s 5-year bond to the comparable 10-year bond, as well as the spread pick to the 30-year bond from the 10-year bond. The spread pick-ups are provided on both an absolute and a spread (bp) per turn of duration basis for extending. This accounts for any minor discrepancies in maturity that could have an impact on overall duration change in the perspective trade.

Breaking out some of the more prominent sub industries within REITs, including Apartment, Healthcare, Office and Retail, the results in Exhibits 3 through 6 provide the available spread pick to move from each issuer’s 5-year bond to the comparable 10-year bond.

Exhibit 2. REITs Roll Study

Note: The pricing demonstrates current BVAL indications, and may not be fully reflective of current bid-ask spreads to execute in any given trading strategy. Source: Amherst Pierpont Securities, Bloomberg/TRACE – Spread Indications

Key Takeaways and Trading Recommendations

The steepest overall curves appear to be in the HealthCare and Retail segments. This appears reasonable given questions regarding the long-term operating outlook in each of these respective subgroups relative to the broader REIT sector.
The steep curves in high quality HealthCare operators Ventas (VTR: Baa1/BBB+) and Welltower (WELL: Baa1/BBB+) appear particularly worthwhile for extension trade opportunities. Both names offer about 90 bp to move out from 5s to 10s and about 60 bp to move from 10s to 30s.
Within Retail, we maintain a more favorable view on some of the single-tenant (triple net) issuers versus traditional Retail REITs, and several have steeper curves available within the segment. Realty Income (O: A3/A-) is a single-A issuer with one of the strongest portfolios among single-tenant issuers and offers over 80 bp to extend from 5s to 10s. Likewise, National Retail Properties (NNN: Baa1/BBB+) offers roughly +55 bp to extend from 5s to 10s and is one of the more stable credits in the subgroup. The available pick-up to move into 30s in either of those names is less attractive versus the broader REIT sector.
Not surprisingly, Apartment REITs have the flattest curves among the broader sector; which reflects investors’ perceptions regarding the lower-risk nature of this subgroup. Essex Property Trust (ESS: Baa1/BBB+) offers the best opportunity within that segment to extend from 5s to 10s with an estimated pickup of roughly 48 bps.
There are limited opportunities within the Office segment to move out into the long-end of the curve, with few 30-year bonds outstanding. The one instance available in the study is in Kilroy Realty (KRC: Baa2/BBB), which happens to be among the flattest and least attractive names for extension trades within the entire sector.

Not every trade will be readily available for execution, as demand for longer-dated paper remains strong in both the primary and secondary markets, and sourcing appropriate bonds remains a challenge to all investors. Market liquidity in a lot of these names may currently be limited; however, having a playbook in mind allows investors to react more vigilantly if and when opportunities to extend or game duration become available.

Exhibit 3. Apartment REITs

Exhibit 4. Healthcare REITs

Exhibit 5. Office REITs

Exhibit 6. Retail and Single-Tenant REITs

Note: The pricing demonstrates current BVAL indications, and may not be fully reflective of current bid-ask spreads to execute in any given trading strategy.
Source: Amherst Pierpont Securities, Bloomberg/TRACE – Spread Indications

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jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

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