Sovran Self Storage and its operating partnership, Sovran Acquisition, have been placed on Rating Watch Negative by Fitch Ratings, which citied weaker credit metrics.
The US company was put on watch after it sealed an agreement to break into new markets in Northern California and Las Vegas through a $1.3bn (€1.2bn) deal to buy operator LifeStorage.
Fitch Ratings said the weakening of the issuer’s “key credit metrics” after the LifeStorage acquisition from TPG Capital and Jasper Ridge Partners “more than offset the headline improvements in portfolio quality”.
It added: “The low going-in yield along with the transaction being initially funded with less equity (50%) than Sovran’s typical 70% results in headline metrics weakening materially upon the closing of the transaction.”
The rating action highlights the financial structure of self-storage companies – a sector US pension funds such as the Employees Retirement System of Texas have started targeting.
The sector is regarded as a niche opportunity to generate strong returns as larger self-storage REITs consolidate fragmented property ownership and become more professionalised.
Sovran has secured $1.35bn in bridge financing to “provide certainty of closure” and intends to finance the transaction with proceeds from contemplated equity and debt offerings.
Sovran, shortly after announcing the agreement to acquire LifeStorage last week, launched a public offering of 6m shares of common stock, targeting net proceeds totalling approximately $578.4m.
Fitch Ratings, however, contends that the price for LifeStorage may be too high.
“Sovran paid a premium price in Fitch’s view,” the agency’s rating said.
“The transaction is expensive considering how few REITs trade at similar valuations across all asset classes and quality, despite the fact the initial 4.8% cap rate is comparable with the implied cap rates for other self-storage REITs.”
However, Robert W Baird & Co struck a more optimistic note.
“While the company is paying up for size and new markets, adding Northern California and Las Vegas, as well as adding density in existing markets, should help improve portfolio metrics and warrant an implied cap rate closer to the other self-storage peers,” it said.
Recognising that “pricing is aggressive,” Baird said the portfolio “makes sense” given the improvement in demographics and the company’s attractive cost of equity – “it’s the right time to be buying”.
Risk remains that Sovran will be unable to finance the transaction on terms that will allow the company to reduce its leverage from the 6x that Fitch Ratings estimates it will reach at the closing of its acquisition later this year.
Sovran’s leverage had previously registered a 4.2x quarterly average from the fourth quarter of 2012 to the first quarter of this year.
One option for long-term financing is a public bond issue.
However, Fitch cautions that there is “execution risk surrounding Sovran issuing a public unsecured bond given the lack of inaugural REIT issuers since early 2015”.