Structured Finance

REITs/U.S. and Canada

Special Report
TRuPS in REITS
A Primer

Analysts „ Summary
Matthew D. Gallino Trust preferred securities (TRuPS) have become increasingly
+1 212 908-0218 commonplace in the real estate investment trust (REIT) universe in
matthew.gallino@fitchratings.com 2005. This has resulted in many questions concerning Fitch’s view of
how this affects the REIT market. “TRuPS in REITS (A Primer)”
Tara S. Innes
+1 212 908-0361
attempts to summarize and address these questions.
tara.innes@fitchratings.com
Approximately 110 companies in the 180-company REIT universe are
not publicly rated by any rating agency, and most of these have less
than $1 billion of equity capital. These companies tend to have very
limited access to the market for long-term, committed unsecured
financing. However, in order to meet even modest growth targets,
REITs must have access to unsecured capital. Essentially, for lenders
to provide secured financing for portfolio growth, REITs need to have
a certain amount of their own unsecured funds to provide the lender
with a cushion in the event of asset devaluation or default. Without
unsecured capital, a REIT’s ability to grow is largely limited to its
ability to increase the leverage on its existing capital base.

REITs are especially reliant on capital access because their ability to

retain earnings is limited or nonexistent, depending on the company’s
specific business model. An ordinary C-Corp, absent operating losses
and excessive distribution, can often retain sufficient earnings that it
can reinvest. However, REITs, which are required to pay 90% of their
taxable income to shareholders in the form of dividends, have no such
luxury. This is compounded by the fact that REITs, like most C-Corps,
tend to be reluctant to have secondary equity offerings due to dilution
concerns.

Many unrated issuers could theoretically tap unsecured capital markets

but generally only at a prohibitive cost from both an economic and
operating flexibility standpoint. There are several reasons for this, but
for many REITs that have accessed the TRuPS market, it is due to
some combination of very limited operating histories, poor or
inconsistent financial performance, high leverage or lack of
unencumbered assets to make unsecured investors comfortable. Also,
covenants associated with unsecured bank lines, bonds or term loans
impose limitations or thresholds on key metrics, such as fixed-charge
coverage, leverage and net worth. In turn, these limitations would
likely be unpalatable to young or small companies looking to
aggressively expand and make strategic acquisitions. In addition, the
cost may be prohibitive for certain issuers, such as those in the
residential mortgage market, where net interest margins are often less
than 2% with secured financing.

In 2005, TRuPS, which have long been a staple for commercial banks
and insurance companies, have arrived to help fill the vacuum of

December 21, 2005

www.fitchratings.com
 Structured Finance
Issuing Organization

Parent Company

(Generally, a Public REIT)

OP Subsidiary
Guarantee
Junior
(from Parent, (Contains Most of Organizations Subordinated
OP, or Both) Assets and Liabilities) Note

Delaware Statutory Trust Proceeds

(Trust Preferred Security Issuer)

Trust Proceeds
Preferred
Security
Trust Preferred CDO
(Investor)

OP – Operating partnership. CDO – Collateralized debt obligation. REIT – Real estate investment trust. Source: Company reports.

unsecured capital available to the unrated REIT
marketplace as well as for some real estate operating
companies (REOCs) and homebuilders. Rather than
being offered on an individual basis, TRuPS are
pooled and sold to investors in the format of a
collateralized debt obligation (CDO). Each CDO has
TRuPS from as many as 25 different issuers,
reducing an end-investors exposure to the failure of a
few of the underlying entities. Because the risk is
perceived to be somewhat lower through pooling and
diversity, the cost is also lower, making it more
economical than bank debt for the issuer. For small
issuers, it also avoids the expense and effort required
to independently launch a preferred stock or
unsecured bond program. It has also helped fill a void
for investors seeking new investment opportunities in
real estate but too risk-averse to invest in single
unrated REITs.
„ Basics
TRuPS are unsecured subordinated instruments that
in most cases are subordinate to all forms of capital
in a REIT’s capital structure, except common equity
and most other forms of preferred equity. To date in
the REIT universe, most issuances have had a 30-
year legal maturity but are callable within five years
by the issuer. Financial covenants governing the
security have generally been nonexistent, although
guarantees from the issuing organization’s parent
company are often provided to guarantee repayment.
In certain cases, issuers of the securities have the
right to defer (but not cancel) payments for up to 20
consecutive quarterly periods.
The result is a relatively flexible form of unsecured,
subordinated capital that most issuers will apply
toward portfolio growth. Proceeds from the trust
preferred security issuance are generally used by
most issuers to help fund the purchase of new
portfolio investments. Capital raised from the
offering often helps provide the company’s “down
payment” when it seeks secured financing. For
example, a repurchase agreement (repo) may provide
a REIT with an advance rate of 95 cents per dollar of
pledged collateral. In this example, proceeds from the
TRuPS will be used to purchase the remaining five
cents of collateral to provide the necessary cushion
for the repo provider. Similarly, a mortgage lender
may require an equity REIT to have a maximum 85%
loan to value on a potential acquisition. Proceeds
from the TRuPs provide REITs with this necessary
equity capital.
The potential portfolio effect from this is significant.
A residential mortgage REIT that issues $25 million
of TRuPS may leverage this amount between 10
times (x) and, in a few cases, as high as 25x. This
translates to a growth in portfolio investments by
$250 million to $625 million. For residential issuers
that have completed two $25 million issuances of

TRuPS in REITS
2
 Structured Finance
Example of Trust Preferred CDO Arrangement

Assets Liabilities and Equity

REIT Issuer 1 ‘AAA’

REIT Issuer 2 CDO Trust

(Delaware ‘AA’
Statutory
Trust
REIT Issuer 3 Preferred
Trust)
Issuance Issuance
of Tranches
of CDO ‘A’
REIT Issuer 4 Notes
Owns Trust
Preferred Notes
And other
Investments such
REIT Issuer 5…..
As CMBS and
‘BBB’
REIT Bonds

…REIT Issuer X
Issues CDO Notes ‘BB’
To Fund Asset
Origination
Assorted CMBS
Secondary Market
Purchases Equity
IG REIT Bonds

CMBS – Commercial mortgage backed securities. CDO – Collateralized debt obligation. REIT – Real estate investment trust. Note: Example only.
All tranches shown may not exist, and diagram shown is not proportionate. Source: Company reports.

TRuPS, the net portfolio growth supported could be
more than $1 billion. For equity REITs purchasing a
property on an 85% loan to value, a $25 million
TRuPS issuance will provide the company with
enough equity capital to permit the purchase of a
$167 million property.
„ How It Works
For most issuers, a Delaware Statutory Trust is
created within the capital structure of the issuing
company. This entity has no other assets or liabilities
other than to facilitate the TRuPS issuance. The trust,
which is 100% owned directly or indirectly by the
parent company, issues the TRuPS to the CDO (or to
a warehouse entity set up by the CDO originator, if
the CDO is still in a ramp-up phase) and receives the
proceeds from the offering. The trust then loans the
proceeds from the TRuPS offering to the parent
company or other operating subsidiary of the parent
company, such as an operating partnership. This loan
is generally in the form of a junior subordinated note,
which pays interest to the trust that corresponds to the
trust’s dividend obligations associated with the
TRuPS offering. On the company’s consolidated
financials, this structure generally appears as a junior
subordinated loan or note.
The TRuPS and the corresponding junior
subordinated notes typically do not have any
individual covenants, such as net worth, fixed-charge
coverage or unencumbered asset tests, which are
common features for REIT debt. In limited cases,
REITs have the ability to defer up to 20 cumulative
quarters of dividend payments. However, this has
generally been limited to issuers with stronger
relative credit quality. Nevertheless, for purposes of
the note holders, such a deferral is treated as a default
by the CDO structure and can result in changes to the
cash flow waterfall for the CDO note holders.
Some trust preferred CDOs have applied broad-based
covenant tests, wherein multiple issuers that fall
below certain common net worth or fixed-charge
coverage tests could result in changes in the cash
flow waterfall. Still, these issues will not affect the

TRuPS in REITS
3

specific issuer (although they may create challenges
if the issuers try to return to the market).
In some casers, a guarantee is provided to the trust by
the parent company or other operating subsidiary
with respect to repayment of the TRuPS. Most REITs
tend to have very few assets at the parent company
level but own an operating partnership that houses
most real estate assets. This is more commonly called
an umbrella partnership REIT (UPREIT). The
operating partnership often issues most of the REIT’s
secured, through special-purpose vehicles (SPVs),
and unsecured debt, and as a result, any debt
obligations of other entities within the issuing
organization will be structurally subordinated to
obligations within the operating partnership. As a
result, although the TRuPS issued by a trust may
have the implied security of a parent company
guarantee or even an operating partnership guarantee,
this would still be structurally subordinate to
obligations within these entities, which for most
REITs would include substantially all of the
liabilities.
„ Pros and Cons
Issuing Companies
All other factors being equal, Fitch tends to view the
issuance of TRuPS as a positive for most issuers. The
TRuPS market has provided a source of relatively
low-cost, long-term unsecured capital to small REITs
that have traditionally not had meaningful or
consistent access to these markets.
Many of the small and/or unrated residential and
commercial mortgage REITs operating today are
heavily reliant on short-term secured capital, such as
reverse repo or warehouse agreements for their
funding. These arrangements, while low-cost and
plentiful in today’s highly liquid capital markets
environment, tend to contain very short commitments
and are often subject to margin calls. Because they
are not committed, or not committed for long, they
create substantial interest rate and funding maturity
gaps with the much longer term nature of the REITs’
assets.
Similarly, unrated equity REITs are often reliant on
the mortgage, commercial mortgage-backed
securities (CMBS) and CDO markets. While these
forms of capital are plentiful in a liquid capital
markets environment, they tend to severely limit an
issuer’s operating flexibility, have significant
TRuPS in REITS
4
Structured Finance
constraints an issuer’s ability to reposition a property
and come with onerous prepayment penalties, making
an asset sale or transfer difficult and expensive.
As these issuers and the capital markets have
evolved, increasingly creative securitization and
structures have been implemented to provide
matched funding. These include CMBS, residential
mortgage-backed securities (RMBS) and CDO
technology. Still, while these satisfy a REIT’s needs
for long-term fixed funding, they do not eliminate the
need for flexible unsecured capital.
Whether short- or long-term secured financing is
used, mortgage and equity REITs require generally
between 4%–35% of their own unsecured capital to
purchase assets on a secured basis. However, as
many residential and commercial mortgage REITs
have limited operating histories and a substantial
portion or all of their assets are encumbered, they
tend to have zero access to the public or private
unsecured debt markets, and their narrow operating
margins, particularly on the residential side, tend to
render the long-term senior unsecured debt markets
economically unfeasible. Equity REITs without
unencumbered assets tend to be in the same boat with
respect to unsecured market access.
Nevertheless, in order to continue their growth,
issuers need the ability to access unsecured capital in
order to raise the minimum 4%–35% they require to
obtain secured financing. As issuers have grown,
most of their initial public offering (IPO) capital has
been used to fund assets, and with very limited
internal capital formation rates, they are required to
look elsewhere to raise capital. Secondary stock
offerings are a relatively unpopular choice, as
mortgage REIT stocks have been under pressure due
to rising interest rates and issuing additional stock
would create dilution.
A solution to this dilemma for many issuers has been
the TRuPS market. There is little downside to this
market for most issuers. Because they are
substantially all included in CDOs, individual issuers
with credit issues or limited operating histories are
often able to issue because the CDO investor takes
comfort in the size and diversity of the much larger
pool being invested.
Larger investment-grade issuers have also, in certain
cases, accessed the TRuPS market due to its low cost
and relatively efficient execution. Nevertheless, some
larger issuers avoid this market because they already

Summary of Trust Preferred Security Treatment
Equity Credit Range (%) Security Type
60–69 Long-dated at issuance and deeply subordinated in standing; available deferral period of three years or
longer; weak financial covenants, if any.
0–49 Deferral period less than three years; financial covenants similar to senior debt.
Source: Fitch Ratings’ "Hybrid Securities: Evaluating the Impact – Revisited," available at www.fitchratings.com.
have access to solid execution on their existing debt
and preferred stock programs. Also, the $25 million–
$50 million slugs in which TRuPS have so far been
offered are not large enough to make a dent in their
capital requirements relative to the legal resources
needed to execute the transaction. Certain issuers
have circumvented this issue by issuing larger
amounts, which have been divided into multiple
CDOs.
As REITs continue to issue TRuPS, however, they
will need to consider its effect on their existing or
future preferred stock ratings. In most cases, TRuPS
are junior to senior unsecured debt but senior to
preferred stock. This increases the gap between an
issuer’s ratio of total debt-to-undepreciated book
capital and total debt plus preferred stock-to-
undepreciated book capital. This metric plays a
significant role in determining the notching between
the senior and preferred ratings. A larger gap
increases the likelihood that the notching will be
higher.
Investors
One of the most critical aspects of assessing a TRuPS
is considering the issuing company’s legal structure.
The key question to consider is, how close is the
issuing trust to the assets? Most REITs that have
issued TRuPS so far tend to have little to no
unencumbered assets, which means that in a
liquidation scenario, there would likely be little to no
assets remaining for satisfaction of the subordinated
unsecured obligation. In essence, other secured
lenders already have a first lien or a pledge of the
collateral.
Many structures attempt to use a parent guarantee to
work around the subordination issues. Nevertheless,
the guarantee is only as good as the entity that offers
it. For most REITs, the parent-level organization has
very few assets and is relying on the operating
partnership or other subsidiaries for repayment.
In addition, most unsecured capital currently
available to the REIT sector, even among investment-
grade issuers, comes with covenants. By contrast, the
5
Structured Finance
REIT TRuPS and their counterpart junior
subordinated notes have no direct security-level
financial covenants that would allow an investor to
declare a default as a company’s financial condition
deteriorated. However, in some cases, the collateral
manager for the CDO transaction can declare a
default in the event that a company’s assessment
drops to ‘CC’ or below. Furthermore, many securities
have a mechanism that allows deferral of payments
for up to 20 quarters, particularly in the case of
issuers with stronger credit quality.
In Fitch’s view, the real strength for investors is that
TRuPS are packaged in CDOs. To date, transactions,
such as Merrill Lynch & Co., Inc.’s Taberna Capital
Management LLC transactions have had
approximately 25 issuers, each totaling between
$700 million–$1 billion in total assets. The size and
relative diversity of the CDO transactions help offset
the risk of default any one issuer will cause.
„ Treatment in Leverage Calculations
For purposes of calculating leverage, TRuPS are
treated as neither 100% debt nor 100% equity. Based
on the structural characteristics of most recently
issued TRuPS in the REIT universe, most will
receive between 60%–69% equity credit. This means
that for a $100 million issuance of TRuPS (which
show up as junior subordinated notes on most REIT
balance sheets), between $60 million–$69 million of
the TRuPS will count as equity in the leverage
calculation, while the remainder will be treated as
debt.
Nevertheless, the overall equity credit range for
TRuPS in general is 0%–69%. The determining
factor as to exactly where in the 0%–69% range each
company will come out depends on the length of time
to maturity and the length of time that an issuer can
defer interest and/or dividend payments. A full
detailed discussion of this methodology can be found
in the criteria report, “Hybrid Securities: Evaluating
the Credit Impact — Revisited,” which can be found
on Fitch’s Web site.
TRuPS in REITS
 Structured Finance
„ Treatment of Interest or Dividends „ Notching
in Operating Performance In Fitch’s formal rating process, TRuPS issuances
In general, Fitch will include the expense for either will be notched off of the issuer default rating (IDR)
the junior subordinated notes or the TRuPS in both of either the parent company or operating
interest expense and fixed-coverage charge partnership, depending on the company’s business
calculations. Although the dividends are often model and legal structure. It is anticipated that for
deferrable, they are also cumulative. Fitch believes most issuers with a below-investment-grade IDR, this
that, for issuers that use it, this capital source is a would be two or three notches below the IDR.
direct contributor to the long-term sustainability of a
REIT’s operating platform and, as a result, expects Nevertheless, this is not a concrete rule, and the
that it will be maintained through operating cycles on notching determination will heavily consider the
a timely basis. statutory trust’s location in the company’s
consolidated legal organization structure. The further
removed it is from quality, liquid assets, the greater
likelihood the notching will be larger. Specific
attention is paid to the availability and liquidity of
unencumbered assets and the cash flows generated by
such assets.

Copyright © 2005 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. One State Street Plaza, NY, NY 10004.
Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. All of the
information contained herein is based on information obtained from issuers, other obligors, underwriters, and other sources which Fitch believes to be reliable. Fitch does not audit or verify the
truth or accuracy of any such information. As a result, the information in this report is provided “as is” without any representation or warranty of any kind. A Fitch rating is an opinion as to the
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TRuPS in REITS
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