Outlook for REITs Holds Steady

NEW YORK CITY-Fitch Ratings said Wednesday that REITs’ access to capital markets and stronger liquidity positions support a stable outlook for the sector in 2011. Other points in favor include relatively unchanged coverage metrics and a strengthening asset sales environment, one in which REITs are particularly at home.

“REIT acquisition volume should increase in 2011 with significant secured debt maturities coming due and asset prices still well below peak valuation,” Steven Marks, managing director and US REIT group head at Fitch, says in a release.

Contained in Marks’ observation, though, is a hint to what Fitch sees as potential clouds on the REITs’ horizon. The ratings agency cites expectations of continued negative property-level fundamentals across most asset classes, fragile improvement in the economy and continued elevated leverage across the REIT sector.

Fitch says it would consider revising the sector’s outlook from “stable” to “positive” if several conditions were met. They include: capital markets access and liquidity remaining strong, same-store NOI turning positive for several consecutive quarters for most property types, sector-wide leverage decreasing, fixed charge coverage increasing, transaction volume improving and a macroeconomic backdrop that results in sustained job growth and thus greater demand for space.

Conversely, Fitch says in its report, the outlook could be revised to negative “if access to capital reverted to the weak levels observed in late 2008 and early 2009, issuers increased their use of secured debt to the detriment of unsecured bondholders thereby causing strains in the quality of unencumbered asset pools, issuers embraced riskier strategies such as speculative development and if issuers increased common stock dividends to a level that significantly reduced retained cash flows.”

The outlook for multifamily fundamentals has improved over last year, Fitch says, and therefore provides “a solid foundation” to the agency’s stable assessment for REITS in the coming year. For apartment REITs, the advantages include limited supply and access to low-cost financing from Fannie Mae and Freddie Mac.

Although fundamentals are moderating across Fitch’s rated office REIT universe, the agency cites unemployment as an ongoing concern affecting demand growth for these companies’ rentable space. It’s especially prevalent in suburban markets, Fitch says. Similarly, industrial REITs face stress from weakening fundamentals.

Weak consumer spending and high unemployment continue to weigh on the fundamentals for retail properties, but Fitch says the outlook for retail-owning REITs is Stable. “Most REITs in this asset class have improved and stabilized their balance sheets, capitalization, liquidity and financial flexibility,” says Fitch.

Fitch also gives plaudits to the health care sector, owing to demographic trends portfolio diversity and limited supply. REITs in this class generally have good liquidity and strong balance sheets, according to the agency’s report.

Separately, a Deloitte report on the overall outlook for commercial real estate notes that REITs are ahead of the game in rebounding. “The main difference in recovery speed is that property fundamentals such as vacancy, rent and values are closely linked to the sluggish economy, while REITs are driven by investor perception of performance relative to competing asset classes such as stocks and bonds,” according to Deloitte. Year to date, REITs have posted ROI of 23.6% as of Oct. 14, in line with full-year ’09 levels and a remarkable comeback from the negative 37.3% seen in ’08.