Net-lease real estate investment trust, or REIT, Realty Income (NYSE: O) recently announced a new commercial paper program to add to the company's liquidity. As this type of financing isn't well understood by real estate investors, here's a quick overview of what a commercial paper program is and why a REIT might benefit by starting such a program.
Commercial paper programs, explained
Commercial paper is a short-term debt instrument used by corporations to finance borrowing needs. Commercial paper typically matures in about a month or less but can be issued with maturity periods of several months or longer. Think of commercial paper as a corporate bond but with a much shorter maturity than is typically expected.
Commercial paper is an unsecured form of debt. This means these debt obligations aren't backed by any specific collateral. As an everyday example, a mortgage is a form of secured debt, as it's backed by the value of the underlying real estate. A credit card, on the other hand, is an unsecured debt; if you default on your credit cards, your lender won't repossess the items you purchased.
Instead of making interest payments, commercial paper is sold at a discount to its face value. So a corporation may issue $100,000 worth of commercial paper at an actual sale price of $99,500. The buyer of the commercial paper will be paid back $500 more than they spent on the debt security, which represents the return. This is typically dependent on the issuer's credit rating and prevailing market interest rates.
Commercial paper programs will typically specify a maximum borrowing amount and may also specify a particular currency the commercial paper will be denominated in, especially if the company has international operations.
Realty Income's commercial paper program and why it helps the company
Realty Income announced in late August that it had established an unsecured commercial paper program under which it can issue the short-term debt instruments, denominated in U.S. dollars, up to a maximum aggregate amount of $1 billion.
One of the biggest benefits of commercial paper is that as long as it matures in 270 days or less, it doesn't need to be registered with the Securities and Exchange Commission (SEC), unlike most other forms of debt securities. This cuts down on regulatory expenses, making it a cost-effective way to fund short-term borrowing needs. Taking out a bank credit line or issuing bonds can be significantly more costly, so this commercial paper program can help Realty Income save money if it only needs to borrow for a short duration.
It also increases the REIT's total liquidity. Realty Income has a $3 billion revolving credit facility, and this essentially gives the company an additional $1 billion in readily accessible borrowing capacity.
The bottom line
Commercial paper is a smart way for financially solid companies to increase their financial flexibility and reduce their borrowing costs. This is especially true for a company like Realty Income, which has A-rated credit and can issue commercial paper at a very low yield.