In the past week, New York-based Fitch Ratings has downgraded Denver-based AIMCO and Birmingham, Ala.-based Colonial Properties Trust. The two REITs are saddled with debt levels of about 80 percent, which makes them the two most highly leveraged REITs in the apartment space, according to Green Street Advisors, a Newport Beach, Calif.-based firm that tracks public real estate companies.
Fitch downgraded AIMCO from BBB- to BB+ issuer default rating, essentially dropping it to junk bond status. Last fall, it also moved the company’s outlook to negative. The main issue: Less than 10 percent of AIMCO's assets have unencumbered debt. Its stock price has dropped more than 30 percent this year.
“They don’t have a lot of unencumbered assets,” says Sean Pattap, a director with Fitch. “That’s consistent with their strategy of employing nonrecourse, property-specific debt across most of their portfolio. With the credit markets dislocated where they were and our focus on liquidity in terms of having unencumbered pools, the fact that these corporate obligations are structurally subordinate to specific property level debt was factored into the ratings action.”
Of course, unlike many of its peers, AIMCO’s strategy is to utilize long-term debt on a property basis. That lowers the REIT's unencumbered asset pool but also softens the blow of Fitch’s downgrade. “You obviously don’t like it, but it really doesn’t do much,” says Ernie Freedman, AIMCO’s deputy CFO. “The way we’re structured from a capital standpoint, there’s not much of an impact for us. We’re doing all of our financing at the property level. It would impact us if we’re trying to get a line of credit, but we’ve already taken care of that. That said, we want to maintain as high a rating as we can get.”
Analysts who cover the company also are downplaying the effects. “For someone like AIMCO, who is mainly a secured borrower, I’m not sure it’s a huge deal,” says Andrew J. McCulloch, an analyst with Green Street Advisors. “You always want to have a higher rating just because you have more options if they want to be a bigger unsecured buyer down the road.”
Pattap says the fact that operating fundamentals will continue to be a challenge was another issue driving Fitch's decision to downgrade AIMCO. That was also the primary driver behind its decision to downgrade Colonial from 'BB+' to 'BBB-' in March. The REIT, which declined to comment for this story, saw its same-store NOI drop 3.2 percent in the first quarter of 2009, but Pattap contends its exposure in markets such as Charlotte, N.C.; Raleigh, N.C.; and Orlando, Fla.—along with how the company performed in the downturn of the early 2000s—could signal more trouble. “Some of their top markets have been more adversely impacted than their overall portfolio,” he says.
Righting the Ship
Despite the recent downgrades, Fitch has given both AIMCO and Colonial stable outlooks. The agency is pleased with Colonial’s steps to improve liquidity, such as launching and closing a tender offer to repurchase $250 million in bonds with 2010 and 2011 maturities. They bought the bonds at a 27 percent discount to par. “The company continues to repurchase their bonds in open market at discounts to par,” Pattap says. “The stable outlook is a result of the company’s improvement in some liquidity enhancing measures.”
Liquidity is also the buzzword for AIMCO. It has a $475 million term loan due in March 2011 on its books. It paid $125 million and has $350 million left. It’s primarily relying on asset sales to attack that loan, engaging in a selling frenzy in the first quarter of 2009. Right now, it has $600 million in assets under contract, $500 million under negotiation, and $800 million on the block.
“The reason for the urgency is the term loan, but we’ve been saying for a couple of years now that we have to get down to our 20 core markets,” Freedman says. “We still need to sell $2 billion to $3 billion worth of assets to get us to the portfolio we want to have. We would be a seller anyway, but with the term coming due in a little less than two years, there’s definitely more urgency in getting those asset sales done.”
If property sales don’t materialize to that level, the company says there are other ways to bite into the remaining $350 million that is due. It’s already cut its dividends by about 60 percent. "The dividends reduction conserves some cash to pay off the term loan, if needed,” Freedman says. “We think we can get there with sales. If we can’t get there with sales, we can get there with refinancing proceeds from our property debt. We have extra cash being available. It’s hard a road to hoe, if we don’t have any property sales. But we feel we'll have property sales.”