Early Signs of Weakness in REIT Liquidity

NEW YORK CITY—Equity REITs are showing early signs of weakening when it comes to liquidity, Fitch Ratings says in a new report. “REITs' cost of debt capital remains attractive for the larger and more seasoned companies; however, average unsecured bond spreads have risen over 25% from the same period in the prior year in response to macroeconomic factors,” according to the report.

The median liquidity coverage ratio for select US equity REITs is 1.2x for July 1, 2015 through Dec. 31, 2017, says Fitch. This represents a slight decline from the three prior comparable timeframes.

Further, according to the report, there's “significant variability across the major property types” when it comes to liquidity coverage. The median liquidity coverage ratio is currently 2.0x for healthcare, 1.4x for industrial, 1.4x for multifamily, 1.1x for retail and 0.9x for office.

“Lack of access to the public unsecured bond markets is forcing potential first-time REIT issuers to consider alternative sources of capital and rely more heavily on term loans and revolving lines of credit,” says managing director Steven Marks. Additionally, 10-year bond maturities from relatively heavy 2007 issuance are a meaningful liquidity use for several issuers, pushing down liquidity coverage.

Behind the slowdown, Fitch says, is the change of control concerns that surfaced this past April, after Blackstone Property Partners' announced acquisition of Excel Trust. These have been “a major factor halting public unsecured bond issuance for potential first-time issuers,” according to Fitch. “After a record-setting first quarter of unsecured issuance, the second quarter slowed as investors and new issuers negotiated the inclusion (or not) of CoC provisions amid an evolving macroeconomic backdrop.”

Near term, “While seasoned REIT issuers have been unaffected, public issuance volume could decelerate even further should bond investors demand CoC provisions for seasoned, larger or higher-rated issuers,” Marks says.

The difference between REIT and corporate bond spreads, as measured by yield to worst, has fallen to as low as three basis points in the past month after hovering in the 10- to 15-bp range through early in the second quarter. Fitch notes that while concerns surrounding monetary policy and global growth have impacted both corporate and REIT credit spreads, corporate credit spreads have risen at more than twice the rate of REIT spreads since early 2014, due mainly to oil and gas issuers.

As another sign of what Fitch calls “cracks” in REITs' liquidity, preferred stock issuance year to date has accounted for the lowest percentage of total capital issuance in the past 10 years other than 2009, when no preferred stock was issued. “The increase in preferred stock market yields near or above contractual yields has eliminated the issuers' ability to redeem higher cost preferred stock via proceeds from less costly new issuance,” according to Fitch.

That being said, NAREIT said Thursday that although REITs did not avoid August's broad market correction, they fared “somewhat better” than other major indices during the month. The FTSE NAREIT All REITs Index, the broadest benchmark of the stock exchange-traded US REIT industry containing both equity and mortgage REITs, lost 5.68% on a total return basis during August. In comparison, the S&P 500's total return fell 6.03% in August, and the S&P Composite 1500, which, like the REIT market, includes large mid- and small-cap stocks, was down 5.97%.