In many cases, the bonds are already a year or two old, which means the put date is less than three years away, Mr. Paolone noted.
Many REIT converts are trading at discounts that range from 5% to 25%, estimated Michael Mueller, another JPMorgan analyst.
He named a number of REIT converts that he considers particularly attractive based on today's trading prices: Pennsylvania Real Estate Investment Trust of Philadelphia has a 4% coupon and recently traded at 74.50 (this means that the Penn REIT is trading at 74.5% of par, or $745 for a bond with a face value of $1,000), General Growth Properties Inc. in Chicago has a 3.98% coupon and recently traded at 74.50, Kilroy Realty Corp. in Los Angeles offers a 3.25% coupon and recently traded at 79.88, Lexington Realty Trust in New York has a coupon of 5.45% and recently traded at 88.50, Macerich Co. in Santa Monica, Calif., offers a coupon of 3.25% and recently traded at 80, SL Green Realty Corp. of New York has a coupon of 3% and recently traded at 80.50, and Brandywine Realty Trust of Radnor, Pa., offers a coupon of 3.875% and recently traded at 89. All have put/call dates either in late 2011 or in the first half of 2012.
The only risk to the converts is if the REIT becomes insolvent or files for a Chapter 11 bankruptcy — a scenario Mr. Paolone and Mr. Mueller think is highly unlikely in the names they listed.
"The probability of these companies' going bankrupt is pretty slim to none," Mr. Paolone said.
REITs began tapping into the convertible-debenture market when real estate prices were surging two years ago.
"REITs went bananas and issued tons of this paper in 2006 and 2007 because the stock prices were trading at such a high level," Mr. Paolone said. He estimated that REITs issued about $30 billion of convertible debentures over the span of a few quarters.
Indeed, the flurry of REIT issuances over a few quarters suddenly made REITs a major player in the convert market almost overnight.
"They went from nothing to about 7% of the total convertible-debenture market," Mr. Mueller said.
"REITs accessed that market opportunistically and raised capital because they could, not necessarily because they needed to," said Steven Marks, a managing director at Fitch Ratings Ltd. in New York. He said that it was an attractive and cheap way to raise cash.
"The conversion premium was high, and the coupon was typically 1% lower than what companies would be able to get for a straight non-convertible-bond transaction," Mr. Marks said.
The last time REITs jumped into the convert market en masse like this was from 1996 to 1998, when REIT stocks surged to frothy levels.
For the investor, the converts provide an attractive coupon of about 4% on top of the right to convert the debentures into common shares at a certain strike price. At the time, REIT share prices were surging, and the conversions offered a premium above the already lofty stock prices, making them attractive to investors.
But as REIT stocks started taking a hit amid the economic downturn and the credit crunch reared its head, most of the converts stood little chance of hitting the strike price needed to trigger the conversion into common shares. As a result, convert investors, who bought the note based on the belief that the convert options would be valuable, have been dumping the notes.
GENERAL GROWTH
"So at this point, that option is worth nothing, and all you're left with is the bond," Mr. Paolone said. "They've blown out of them and traded them to more depressed levels."
The REIT converts taking the biggest hit are those issued by REITs that are viewed as risky based on debt levels, property locations or other issues. For example, General Growth's debt woes have made investors nervous.
"If there are 10 [phone] calls that come in about converts, five of them are asking about General Growth," Mr. Mueller said.
"Everybody is so worried about General Growth's debt levels overall that everything in their capital structure is trading poorly," Mr. Paolone said.
Investors also are jittery about mall REIT Macerich because of the company's big exposure to the troubled Phoenix market, exposure to the volatile retail industry and big development pipeline.
However, Mr. Paolone and Mr. Mueller aren't worried about General Growth's financial future or the health of the other REITs named.
"This may be a rough patch in the cycle for them, but we don't think they're going bankrupt," Mr. Paolone said. By investing in converts, "you can get rid of the volatility in the stock and get a good risk-adjusted return by moving and playing the convert in the capital structure."
E-mail Janet Morrissey at jmorrissey@investmentnews.com.
