Momentum Shifting to Later-Cycle Property Sectors for Equity REITs

By Stephen Boyd, CFA, Director, Fitch Ratings

Equity REITs that own early-cycle property types such as hotels, apartments, and self-storage facilities should continue to post the strongest internal growth in 2015. That said, growth leadership is likely to transition to later-cycle industrial, office, and retail properties throughout 2015 for which occupancies and rental rate improvements are accelerating and an increasing percentage of near-term lease expirations are for deals signed at distressed rents during the global financial crisis that are now likely well below market.

Accelerating U.S. GDP and employment growth support all REIT property types in 2015. However, office, retail, and, to a lesser extent, industrial properties should continue to benefit from low levels of new supply. Rent increases for these property types have only recently begun to make development feasible in select markets and bank appetites for construction lending to these sectors remains low, albeit improving.

U.S. office property fundamentals should accelerate during 2015. Fitch has seen an increase in its assessment of CBD market conditions to above average from average. This is largely based on Fitch’s expectation for net absorption and rental rate growth to be near the upper bounds of their historical ranges and below-average growth in office supply. Fitch’s view of suburban office fundamentals has shifted to average from below average given the momentum in select Sunbelt markets.

Favorable property fundamentals and improving liquidity underpin Fitch’s positive view towards the industrial REIT sector. Growing strength in the economy, employment, and demographics should positively influence housing starts, auto sales, and retailer productivity, boding well for industrial REITs. Forecast demand of 166 million square feet will outpace supply of 145 million sf in the U.S. in 2015, according to CoStar. This should drive vacancy to 6.7 percent in 2015 from 7 percent in 2014. Market rents continue to improve, and Reis, Inc. data projects annual effective rent growth for 2014 will climb above 3 percent in 2015, up from an estimated 1 percent increase in 2014.