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NEW YORK CITY-Highly-levered REITs may be under increased rating pressure under a new method for measuring leverage, Fitch Ratings said Friday. The revised methodology comes on the heels of the ratings agency’s report that it may soon upgrade its outlook for the sector.

Fitch says measuring leverage by looking at the ratio of net debt to recurring EBITDA provides a better indicator of leverage, because it most accurately captures indebtedness relative to the earnings power of a REIT’s portfolio, and therefore the company’s capacity for debt. “Indications of currently high or increasing debt to recurring operating EBITDA multiples may trigger a ratings review,” says Steven Marks, managing director and US REIT group head at Fitch, in a statement. In a report issued Friday, Fitch says it will use a rising trend in net debt to recurring EBITDA ratio toward an 8.0x to 8.5x multiple as a sign of deterioration toward non-investment-grade ratings, “although the ratio will generally vary by asset class.”

Historically, Fitch has put the emphasis on total debt to undepreciated book capitalization and total debt to total market capitalization. “The relative stability of GAAP UBC continues to make the total debt-to-UBC metric relevant; however, historical cost accounting financial statements do not capture earnings power and may overstate real estate asset values and, as a consequence, understate leverage,” the agency says in the report, titled “Don’t Mind the GAAP for REIT Leverage.”

The Fitch report cites a number of reasons for measuring debt against EBITDA. For one thing, “both net debt and recurring operating EBITDA are objective measures and, thus, are not prone to subjective assessments surrounding asset or equity valuation.” They’re unaffected by changes in management, liquidity position, leveraged cash flow expectations or other factors that affect stock prices, Fitch says. Additionally, net debt and recurring operating EBITDA are not susceptible to immediate changes in market values, and EBITDA captures a REIT’s current earnings power.

On average, multifamily and industrial REITs have the highest debt to EBITDA ratios—8.5 and 8.4, respectively—as of the end of the second quarter, Fitch says in its report. Retails REITs rank third with an average ratio of 6.7, while the healthcare and office sectors both average 5.7.

Friday’s report follows a mid-September announcement that because equity REITs’ access to unsecured debt is improving, Fitch may eventually revise its outlook on the sector from negative to stable if more REITs are able to gain access to unsecured debt over time. The earlier report notes that REITs’ unsecured bond issuance volume and terms “have improved materially” since the end of Q2.

Sixty-two percent of the $6.7 billion in unsecured bond issuance year-to-date occurred in the third quarter, Fitch says. Credit spreads narrowed by 235 basis points over comparable treasuries for Q3 transactions, compared to those issued earlier in the year.

Additionally, REITs have raised approximately $1.5 billion in equity offerings since June 30, bringing the YTD tally to $14.4 billion. “The market’s acceptance of these transactions has enabled REITs to reduce leverage, as well as strengthen liquidity,” Marks says in a release “However, REITs may be reluctant to continue such issuance due to the impact of further dilution to the extent such offerings are more defensive or liquidity-enhancing, as opposed to acquisition-driven, which is a concern.”

Despite industrywide challenges in obtaining debt, REITs are faring better with access to the mortgage financing market, even if, as Fitch says, “most REITs are refinancing mortgages on more onerous terms.” Fitch says most REITs with investment-grade ratings have liquidity surpluses over the next two-and-a-half years.

“REITs are not immune from recent headline risk regarding ongoing commercial real estate fundamental challenges,” Marks says in a release. “However, REITs are set apart from other commercial property owners from a contingent liquidity standpoint.”

With that being said, comments from a REITs panel Thursday at the Bank of America Merrill Lynch Global Real Estate Conference here suggested that players in the sector aren’t taking this track record for granted. “We’re all struggling with the same things these days: all the issues with tenants, with G&A and how to right-size the company,” said Don C. Wood, president and CEO of Rockville, MD-based retail REIT Federal Realty Investment Trust.

He noted, “The severity of this downturn certainly was a surprise. But the fact that we’re in a cyclical business and things were not going to stay the way they were in 2005, 2006 and 2007 was not a surprise. In real estate, it always comes down to what your time horizon is. If you’re looking at operating a company for the long term, as opposed to speculating, it’s different.”

Wood and other panelists emphasized the quality of the real estate as a differentiating factor in distinguishing themselves from the competition. His counterpart at Palo Alto, CA-based multifamily REIT Essex Property Trust, Keith R. Guericke, said his company zeroes in on supply-constrained markets. “If you have 10% unemployment and also have oversupply of product, it really is a serious problem,” said Guericke.

CFO Michael E. LaBelle of Boston Properties told the panel’s audience that his company focuses on non-commodity office buildings. “We try to invest in buildings that have a sense of place, that are unique, that have architectural distinction,” LaBelle said. He added that from a leasing perspective, this focus instills tenants’ employees with a sense of wanting to be there and makes the properties an easier sell to those tenants.

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