What's Wrong With ATM Deals? Plenty!

Reprinted by permission from REIT Wrap Special Report, May 20, 2010

by David Shulman

When the history of the next REIT bear market is written, one of its causes almost certainly will be the widespread uses of at-the-market, or ATM, offerings.

Simply put an ATM is a “slow motion” stock offering that enables an issuer to dribble out shares over an extended period of time based on a defined percentage of trading volume. The total amount of stock involved can be substantial; typically, it runs around 10%, but sometimes as high as 25%, of the shares outstanding at the time of registration with the Securities and Exchange Commission. A REIT with an ATM can issue shares at will; except during “black-out” periods (e.g., surrounding earnings releases).

Roughly a third of the equity REIT universe has an ATM on file with the SEC currently. The list includes some blue-chip REITs [e.g., Avalon Bay (AVB), Boston Properties (BXP), Equity Residential (EQR), and Essex Property Trust (ESS)]. That so many REITs have jumped on the ATM bandwagon is hardly an argument for ATM deals. The case against ATMs was recently (April 20) put forth (convincingly, I’d add) in a piece posted to NAREIT’s website (http://www.nareit.com) by Joe Harvey, president and Chief Investment Officer for Cohen & Steers (CNS), one of the largest buy-side REIT shops. Over roughly two decades, Cohen & Steers and I have occasionally differed on issues; on this one, however, we’re on the same page!

Yes, companies announce when they have signed agreements to offer shares via an ATM. But it is difficult, especially for “retail investors,” to know who is doing the selling. Is it the company (a dilutive sale) or another shareholder? In that way investors large and small alike have an equal opportunity to be “arbed” by the issuer. It is a conundrum that is at odds with the transparency that REITs talk about so frequently. That’s not the only issue, however.

Something more insidious is going on. ATMs create the illusion that equity is cheap and can be sold at will. It is just too easy! Plus, because the costs associated with issuing shares via an ATM offering are well below those associated with a conventional follow-on deal, the sales pitch to REITs by investment bankers is straightforward. Unfortunately, issuing equity is far more serious than a stop at the local ATM to pick up some cash. Specifically, REIT managements that use ATMs don’t have to answer investor questions about the use of proceeds, or the outlook for their businesses. And, investors don’t learn how many shares have been sold via the ATM offering until the REIT issues an announcement; typically, when it announces earnings. Is this the sort of full disclosure and good corporate governance that investors expect from REITs?

It is not surprising that Cohen & Steers along with other dedicated buy-side REIT shops might take issue with the widespread use of ATMs. After all, it is the institutions that get first crack at conventional follow-ons. An advantage they don’t have in the case of ATMs. However, because they are acting in their own self-interest doesn’t put them at odds with the interests of individual investors. Nor does it diminish the validity of the points made by Cohen & Steers’ Harvey.

Personally, I believe the fairest and most transparent way to issue stock is through a rights offering, which gives shareholders in the REIT a pro rata right to maintain their proportionate interest in the company. Though widely used in Europe, Japan and Australia, rights offerings haven’t been used (generally) in the U.S. for decades. Why? It is a long story (grist, perhaps, for a future column).

Thus far, the REIT bull market has papered over the potential negative side-effects of these “stealth equity offerings.” Oftentimes, what feels good at the moment may leave investors with a serious hangover down the road. Consider the rush to embrace forward equity deals, roughly a decade ago. Admittedly, forward equity deals were far more toxic than ATMs. Nevertheless, the law of unintended consequences is ignored at our peril. And there’s no way around the fact that whatever their perceived benefits, ATMs debase the value of the shares outstanding prior to issuing shares via an ATM offering.

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David Shulman was formerly the Senior REIT Analyst at Lehman Brothers. He
is now affiliated with Baruch College, the University of Wisconsin and the
UCLA Anderson Forecast. He can be contacted at:
david.shulman@baruch.cuny.edu.