Uncategorized

Playbook for REIT extension trades and barbell strategies

| 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

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

Exhibit 4. Healthcare 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

Exhibit 5. Office 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

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

admin
john.killian@santander.us
1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

The Library

Search Articles