HOW MUCH LEVERAGE IS TOO MUCH FOR REITs?

The REIT industry is in the throes of a debate over how much debt is appropriate. In a report released last month, Mike Kirby, director of research at Green Street Advisors Inc., a prominent real estate investment trust research firm in Newport Beach, Calif., raised questions about why REITs bother to use any debt at all. Even as real estate prices rose in the decade prior to their peak in early 2007, leverage didn't improve REIT returns, he wrote. Many in the REIT industry agree, and deleveraging is under way. But reducing debt will take longer than most people expect, Mr. Kirby wrote in his report. He was not available for further comment. Others disagree about the need to rid REITs of leverage. REITs overall have 40% to 50% debt, said Tom Bohjalian, a portfolio manager with Cohen & Steers Inc. of New York, and even those with higher debt levels “are more than covering their debt service.” Some REITs got caught by leveraging the spread between their cost of funds and capitalization rates, he added. When borrowing costs rose and cap rates fell, they got caught. “We feel, as part of an optimal capital structure, a modest amount of debt is appropriate — from 25% to 40%,” said Steve Brown, New York-based senior portfolio manager for the American Century Real Estate Fund, advised by American Century Investments of Kansas City, Mo. Properties with stable cash flow, such as assisted-living facilities or skilled-nursing facilities, can support slightly more leverage, Mr. Bohjalian said, while more volatile properties, such as hotels, should have less. -- Dan Jamieson