NEW YORK CITY—The prospect of a Federal Reserve rate hike in December, which is looking increasingly likely, poses near-term volatility for the REIT sector, says Kroll Bond Rating Agency. At the same time, though, an interest rate increase would also have positive implications for equity REITs, according to KBRA's outlook report.
“Any possible Fed interest rate hike to normalize rates will affect borrowing, refinancing cost and valuations of REITs,” the report states. But such a move by the Fed “will also signal a strengthening economy that may lead to increased demand for property space, rising occupancies and higher rental rates.”
Uncertainty surrounding the outcome of the presidential election may also weigh on REITs, and in particular, KBRA points out that the revelation of a $916-million loss declared by Donald Trump on his 1995 tax returns brought heightened scrutiny to the tax treatment of losses. “REITs and other real estate developers and operators can generate losses more easily that other corporations because of the depreciation on the properties under management, which can be used to offset income from rental income,” according to KBRA's report. “While it is unlikely that the Congress will limit or remove this tax provision, the attention has created unnecessary concerns for REITs, which KBRA expects to subside after the election.”
On balance, the ratings agency gives equity REITs a “stable” outlook for the new year, unchanged from 2016. This outlook reflects what KBRA sees as “sufficient debt servicing capabilities, ample access to debt and equity markets, as well as property fundamentals that are positive, although exhibiting signs of moderating rent growth across property types and markets.”
Equity REITs have shown “strong resilience to market volatility and geopolitical uncertainties” throughout a year that has seen plenty of both. KBRA cites “a challenging year with capital markets, the energy sector and high yield bond market all plunging during the first quarter and then sharply reversing course” as Q2 progressed.
As the year rolled on, oil prices stabilized and positive economic data helped bring investors back into bond markets, thereby allowing REITs to issue $24.2 billion in unsecured bonds and raise $23.7 billion in common stock year to date. “The transaction volume compares favorably to $50.8 billion and $50.4 billion raised in 2015 and 2014, respectively,” according to the ratings agency.
Financial metrics such as leverage and fixed-charge coverage remained stable over the past year for REITs with average net debt to EBITDA of 6.6x as of June 30. That compares to 6.7x and 6.5x at the end of '15 and '14, respectively. Average fixed-charge coverage in Q2 was 3.3x, unchanged from 3.3x for full-year '15 and up from 3.0x the year prior.
Across the major property types, fundamentals generally remained positive through Q3. Although operating performance varied by market, “vacancy rates generally held steady, while rent growth exhibited further signs of deceleration,” according to KBRA's report. “These trends are expected to continue into 2017 among the major REIT asset classes, as a maturing property cycle slows occupancy gains and rental increases across markets. On an overall basis, however, job growth is expected to support tenant demand, and contribute to stable operating performance.”
“Any possible Fed interest rate hike to normalize rates will affect borrowing, refinancing cost and valuations of REITs,” the report states. But such a move by the Fed “will also signal a strengthening economy that may lead to increased demand for property space, rising occupancies and higher rental rates.”
Uncertainty surrounding the outcome of the presidential election may also weigh on REITs, and in particular, KBRA points out that the revelation of a $916-million loss declared by Donald Trump on his 1995 tax returns brought heightened scrutiny to the tax treatment of losses. “REITs and other real estate developers and operators can generate losses more easily that other corporations because of the depreciation on the properties under management, which can be used to offset income from rental income,” according to KBRA's report. “While it is unlikely that the Congress will limit or remove this tax provision, the attention has created unnecessary concerns for REITs, which KBRA expects to subside after the election.”
On balance, the ratings agency gives equity REITs a “stable” outlook for the new year, unchanged from 2016. This outlook reflects what KBRA sees as “sufficient debt servicing capabilities, ample access to debt and equity markets, as well as property fundamentals that are positive, although exhibiting signs of moderating rent growth across property types and markets.”
Equity REITs have shown “strong resilience to market volatility and geopolitical uncertainties” throughout a year that has seen plenty of both. KBRA cites “a challenging year with capital markets, the energy sector and high yield bond market all plunging during the first quarter and then sharply reversing course” as Q2 progressed.
As the year rolled on, oil prices stabilized and positive economic data helped bring investors back into bond markets, thereby allowing REITs to issue $24.2 billion in unsecured bonds and raise $23.7 billion in common stock year to date. “The transaction volume compares favorably to $50.8 billion and $50.4 billion raised in 2015 and 2014, respectively,” according to the ratings agency.
Financial metrics such as leverage and fixed-charge coverage remained stable over the past year for REITs with average net debt to EBITDA of 6.6x as of June 30. That compares to 6.7x and 6.5x at the end of '15 and '14, respectively. Average fixed-charge coverage in Q2 was 3.3x, unchanged from 3.3x for full-year '15 and up from 3.0x the year prior.
Across the major property types, fundamentals generally remained positive through Q3. Although operating performance varied by market, “vacancy rates generally held steady, while rent growth exhibited further signs of deceleration,” according to KBRA's report. “These trends are expected to continue into 2017 among the major REIT asset classes, as a maturing property cycle slows occupancy gains and rental increases across markets. On an overall basis, however, job growth is expected to support tenant demand, and contribute to stable operating performance.”
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