REIT Industry Outlook

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

Our overall outlook for REIT ratings is stable.  The outlook is supported by real estate fundamentals for most REIT sectors that have either stabilized or are improving, while REIT balance sheets and liquidity remain strong.  We also have a stable fundamental view for each of the major property sub-sectors (retail, office, industrial, healthcare and lodging), except for multi-family, for which we have a positive outlook.  We expect the multi-family sector will continue to benefit from short-term leases because they allow landlords to raise rents more quickly, as the economy recovers, particularly as declining home ownership has boosted demand and new supply remains reasonable in most markets. Furthermore, as single-family home prices and mortgage rates have increased in recent months, we expect apartment demand will remain strong to the extent the job market continues to improve.

REITs have improved their capital structures despite the fragile economic climate and potential for rising interest rates. Over the past few years, REITs have strengthened their capital structures, proactively accessing available forms of bank, bond and preferred capital to lengthen their debt maturity profiles. Furthermore, they have executed these long-term financings at historically low interest rates that have boosted their earnings and fixed-charge coverage ratios. Strong stock prices and asset pricing have also helped many REITs raise equity, which has helped them reduce leverage from pre-recession levels. Therefore, even though REITs will inevitably face a headwind from higher interest rates, the impact will be manageable.

Looking ahead to 2014 and 2015, our rating actions will reflect less concern about liquidity than the REITs’ ability and willingness to maintain solid credit profiles as they continue to grow. Post financial crisis, REITs have been taking advantage of their capital access to fund acquisition and development opportunities that enhance their market positions, improve asset quality and long-term growth potential. But some REITs have also been executing more transactions that entail higher risk – entering new markets, expanding development pipelines, value-added acquisitions, etc. To date, our concerns have been mitigated as most of these transactions have been funded with a prudent mix of debt and common equity, with REITs adhering to committed leverage targets. However, REITS’ ability to sustain their balance sheet discipline will be key to sustaining their credit quality, especially as rising debt costs could make it tempting to reach for higher levered returns. Company-specific events will likely drive future rating actions.

Other key risks for REITs include potential excess new supply and macro-economic shocks that could weaken real estate demand.   Construction is picking up in some markets, particularly in the industrial, retail outlet and multi-family sectors.  Some of this new supply is being built by the REITs, but developers are also becoming increasingly active as it is becoming easier to obtain financing for good projects in attractive markets.  Our concern is that this supply is being built to accommodate forecasted demand, which could fall short if the already tenuous economic recovery were to reverse course.