Fitch: Weaker Capital Access Impacts REIT Fundamentals

By Keith Loria

Stephen Boyd, Director of U.S. REITs, Fitch Ratings

While REITs have had strong property fundamentals overall, weaker access to capital is causing concern, according to Fitch Ratings‘s recently released commentary.

“Volatility in REIT debt and equity capital markets access has weighed on REIT management sentiment, despite what remains relatively healthy fundamentals for most property types,” Stephen Boyd, Fitch Ratings’ senior director of corporate finance, told Commercial Property Executive. “Geopolitical uncertainty and the related wider repricing of risk/spreads across capital markets has contributed to this.”

According to research conducted by Fitch Ratings, numerous investors are questioning the sustainability of the historically low cap rates underpinning direct property market values, citing persistent net asset value discounts for equity REIT shares, bifurcated public unsecured bond market access and CMBS market disruption.

Boyd noted that broader and more consistent public unsecured bond market access and equity valuations closer to net asset value are two key milestones REITs must pass on the path to normalized capital access.

“Capital access is the linchpin of REIT liquidity, given the inherent regulatory cash-flow retention constraints,” he said. “Therefore, it is important for investors to remain abreast of any environment changes.”

Both solid employment growth and disciplined bank construction lending should keep demand ahead of supply for most property types, allowing for modest one- to two-percentage-point occupancy gains and low to mid double-digit rent growth.

The research shows that not every capital markets sign is discouraging. In fact, CMBS spreads have tightened during March, and REIT equity values have bounced approximately 15 percent off of their February 2016 lows. Additionally, banks continue to show strong appetites for unsecured term loans, and the private placement unsecured bond market is open at reasonably attractive rates, including for inaugural issuers.

Of course, it’s not the same in all parts of the country.

“Weaker oil prices will weigh on oil-centric markets, primarily in Texas,” Boyd said. “Supply-constrained urban markets are generally still performing well. However, we are also monitoring tech-tenant demand, given weaker venture capital fundraising and poor trading for some recent tech company IPOs.”

Looking ahead, Fitch expects CRE fundamentals to remain healthy and cap rates to increase modestly, primarily for lower physical and/or market-quality assets, as REITs adjust their bids for a higher cost of capital and marginal buyers remain on the sidelines until the CMBS market stabilizes.

“Real estate is generally a lagging indicator, so to some extent there is good performance for 2016 already baked in for REITs with longer-lease-duration property portfolios (such as office and retail),” Boyd said. “However, REIT equity markets have traditionally led fundamentals, and performance has been weak for a little more than a year now, notwithstanding a recent rally.”