Fitch: Weaker Capital Access Curbing REITs' Business Enthusiasm

NEW YORK--(BUSINESS WIRE)-- Weaker REIT capital access is casting a shadow over otherwise healthy property operating fundamentals, according to Fitch Ratings.

Persistent net asset value discounts for equity REIT shares, bifurcated public unsecured bond market access and CMBS market disruption have investors questioning the sustainability of the historically low cap rates underpinning direct property market values. Broader and more consistent public unsecured bond market access and equity valuations closer to net asset value are key milestones REITs must pass on the path to normalized capital access.

Most REITs are navigating the more challenging capital markets landscape in a manner consistent with Fitch's rating case expectations. However, some issuers are testing the flexibility of Fitch's negative rating sensitivities by allowing leverage to drift upwards, primarily to help fund development and acquisitions. Many companies have substituted asset sales for equity issuance to fund external investments on a leverage-natural basis, although some have taken a riskier "grow now, sell later" approach, particularly in healthcare, where leverage has weakened considerably more against policy targets relative to other REIT property sectors.

On balance, REIT disposition activity has exceeded our expectations, which were tempered by CMBS market disruption, a key debt funding avenue for investors, particularly for noncore assets in tertiary markets that most REITs are targeting for sale.

However, not all capital markets signs are discouraging. CMBS spreads have tightened during March. REIT equity values have bounced approximately 15% off of their February 2016 lows. 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. Public bond markets are open to established issuers at higher ends of the rating scale (e.g. 'BBB' and above) at attractive terms and weaker REIT credits, at a price. Potential inaugural issuers have been shut out of the public bond markets for approximately one year.

Public bond investors are clearly taking a more conservative view on REIT credits: banks are on the opposite end of the spectrum and private placement bond investors are in between, albeit closer to the former than the latter. Although objectives and return expectations vary, the pricing differential is notably wide and suggests both under- and overabundance of credit discipline by a key REIT unsecured lending constituent. Regardless, the availability of attractively priced unsecured debt alternatives to public bonds challenges discerning which companies are avoiding that market by choice or necessity.

Fitch expects CRE fundamentals to remain healthy and for 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. 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.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

U.S. Office REIT Viewpoints - 1Q16

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=878821

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View source version on businesswire.com: http://www.businesswire.com/news/home/20160404005930/en/

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Stephen Boyd
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Source: Fitch Ratings

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