REITs in an Era of Strong Policy Headwinds

By Stephen Boyd, Senior Director, U.S. REITs, Fitch Ratings

The Trump administration is focused on accelerating U.S. economic growth through infrastructure spending and tax and regulatory reform that would benefit all types of commercial real estate. However, the policy details are uncertain, along with the White House’s ability to successfully navigate the political waters in Washington, D.C.

Further, more restrictive trade and immigration policies could undermine the benefits of faster economic growth. Long-tenor, triple-net retail and health care properties would see the smallest benefits and could suffer valuation declines if stronger economic growth is accompanied by higher inflation and interest rates.

Shorter-lease tenor property types, such as hotels, self storage and apartments, would experience the greatest cash flow growth acceleration, with all else being equal. Office, industrial and retail properties should see continued healthy rent spreads for new and renewal leases.

The Trump administration will likely target so-called shovel-ready projects for infrastructure investments, given their speed to implement. This should provide outsized growth to markets that have infrastructure projects at or near the final planning stages. New York City is one example, with a number of large-scale projects ready to commence, including the train tunnel projects under the Hudson and East River and airport redevelopments at JFK and LaGuardia.

By contrast, some of President Trump’s more restrictive trade and immigration policies could also present numerous headwinds for equity REITs. Higher dividends could pressure REIT liquidity and payout ratios interest expense is no longer deductible in calculating taxable REIT net income. Preferred stock issuance could become more prevalent as a result. Positively, REITs may gain some advantage in competing with smaller, often more highly levered buyers if interest expense is no longer deductible.

Lower corporate tax rates could also reduce the appeal of the REIT corporate tax election, particularly if companies can fully expense capital costs. Growth-focused REITs could largely replicate the REIT tax election benefits without incurring the mandatory cash distribution requirements under such a scenario. Full expensing of capital costs could also encourage more corporate real estate ownership, rather than leasing, which would reduce sale-leaseback transactions and build-to-suit development.