NEW YORK CITY-Although REITs increased their unsecured bank borrowing capacity more frequently and at more attractive terms over the past two years, the specter of rising interest rates may call their ability to continue doing so into question, Fitch Ratings says in a new report. As it is, REITs’ unsecured lines of credit are about 49% larger than they were in 2011, and are being obtained at lower borrowing rates; yet Fitch doesn’t see this downward trend as sustainable.

“The interest rate environment will be challenging and rating actions could be predicated on a REIT’s ability to address an increase in interest rates,” says Steven Marks, managing director and group head of US REITs at the New York City-based ratings agency.  Steven Marks. “The prospect of rising rates and how it affects unsecured lines of credit and pricing also bears close watch.”

Fitch sees some encouragement in the fact that equity REITs have continued to unencumber their portfolios and remove secured debt from their capital structures. Draws on unsecured revolvers and unsecured term loans accounted for 10% of total debt outstanding as of this past Sept. 30, up from 8% roughly two years earlier.

During the same period, REITs’ secured debt declined to 46% from 49%. “REITs trying to become unsecured bond issuers are using both unsecured revolving lines of credit and unsecured term loans to unencumber the portfolio,” says Marks.

In a special report issued last week, Fitch noted that REITs’ leverage remains slightly elevated relative to the long-term average for the sector, despite the material improvements since 2008. Leverage, as measured by net debt to recurring operating EBITDA, was 6.5x in the third quarter of ‘13, down from 8.0x during the 2008-2009 global financial crisis and slightly elevated versus the long-term historical average of 6.4x.

“Fitch envisions leverage improving modestly in 2014, given improving property level cash flows and enhanced cash retention after dividend payments,” according to the report. With few exceptions, the agency doesn’t anticipate that either at-the-market or follow-on common stock offerings will be used to repay indebtedness over the foreseeable future, “but will instead partially fund transactional activity.”

To the extent that issuers reduce leverage levels, Fitch says it will be done “organically, via increases in property level cash flow or through equity funded acquisitions. Large-scale reductions in general and administrative expenses have already taken place, as many REITs mitigated the negative impact of weakening fundamentals on recurring operating EBITDA by scaling back development overhead” during the depths of the downturn.

Long term, Fitch says, the conclusion that REITs are either appropriately levered or under-levered requires one of three scenarios. Either interest rates remain at or below current levels, which the agency thinks is unlikely; the spread between cap rates and Treasuries has a sufficient cushion to withstand a material increase in interest rates; or “there has been an institutional acceptance of real estate as an asset class such that high single digit or even double digit cap rates are no longer plausible.” The report was derived from a series of investor roundtables Fitch conducted recently in Chicago, Boston and New York.