Moody’s Bullish on REITs & REOCs

By Philip Kibel, Associate Managing Director, Real Estate Finance, Moody’s Investors Service

Moody’s outlook for the U.S. real estate investment trusts (REITs) and real estate operating companies (REOCs) that we rate is stable in each of the major underlying property sectors: retail, office, industrial, multi-family, healthcare and lodging. Operating fundamentals in all major property sectors have stabilized after years of post-crisis improvement, but are still improving in some cases. Operating metrics for investment grade REITs in particular are strong. REIT portfolio properties are well occupied and, for the most part, outperform in most of the markets in which they operate. Additionally, rental rates are increasing in most sectors. Although we expect post-crisis earnings improvements of most property types to continue or stabilize, we expect earnings growth to slow. The macroeconomic environment remains unstable given oil prices, European and Chinese economic slowdowns, and instability in the Middle East.

Since the financial crisis, REITs have taken advantage of their capital access to fund acquisition and development opportunities that enhance their market positions, and to improve asset quality and long-term growth. In 2014, REITs issued $31 billion of unsecured debt (a yearly record), $28 billion of common stock and $4.6 billion of preferred shares.[1] Some REITs have also executed higher-risk transactions by entering new markets, by expanding development pipelines and through “value-added” acquisitions. To date, REITs have funded most of these transactions with a prudent mix of debt, common equity and asset sale proceeds while adhering to committed leverage targets. We will monitor REITs’ balance sheet discipline, especially as rising debt costs tempt them to reach for higher levered returns. Looking ahead to 2015, we are monitoring REITs’ ability and willingness to maintain solid credit profiles as they continue to grow.

Other key risks for REITs are (1) higher interest rates; (2) potential excess new supply; and (3) macroeconomic shocks, each of which could weaken real estate demand. Construction is picking up in some markets, particularly in the industrial, retail outlet and multi-family sectors. REITs are building some new supply, but developer activity is increasing in attractive markets because of increased access to capital. However, some of the supply is being built based on higher forecasted demand, assumptions that could prove faulty if the already tenuous economic recovery reverses course.