Fitch: U.S. Equity REITs Can Expect Better Debt Capital Access

U.S. real estate investment trusts should see improving debt capital access following a challenging start to 2016, said Fitch Ratings, New York.

Deteriorating global economic outlooks, capital markets volatility and geopolitical events have crimped lender appetites, but narrowing commercial mortgage-backed securities spreads should draw conduit lenders back into the marketplace, Fitch said.

At the moment debt capital availability remains bifurcated, Fitch said: some companies receive healthy access and others only mediocre. “REITs have selectively tapped the public bond markets, but public bond issuance remains challenging for less-seasoned REIT issuers at attractive prices, although conditions are improving,” said Fitch Managing Director Steven Marks. He noted that unsecured private placement notes and bank term loans remain far more economical for less established and some seasoned low-investment-grade-rated issuers, with all-in interest costs ranging from 0.5 percent (private placement) to 3.0 percent (bank term loans) below comparable public market rates.

Following record-high unsecured term loan issuance last year, REITs have navigated the first half of 2016 by continuing to rely on this secondary source of capital, Marks said. REIT capital issuance fell 11.6 percent year-over year and elevated unsecured term loan issuance as a percentage of total capital raised to date (26.3 percent) in 2016 has prevented the margin from widening further.

Additionally, the unsecured bond market continues to pressure lower-rated REITs to either accept wider risk premiums or find alternative sources of capital such as private placements.

“Meanwhile, some favorable trends continue amid capital markets volatility and the maturation of this cycle,” Marks said, noting that unsecured lines of credit renewed by U.S. equity REITs between February 2014 and May 2016 were nearly 20 percent larger than prior commitment sizes, “which has taken some pressure off most issuers’ liquidity profiles.”

Susan Persin, Senior Director of Research with Trepp, New York, said a positive economic outlook boosted real estate fundamentals and REIT performance in May. She noted that retail sales grew 1.3 percent in May and new home sales and resales increased sharply.

“[But] this positive news was tempered by the worse-than-expected April jobs report that reflected a slowdown in hiring since the first quarter,” Persin said. “Some retailers also posted disappointing first quarter earnings and others announced plans to close shop as e-commerce sites continued to come out ahead of physical stores.”

For the most part, REIT investors shook off the negative economic news, Persin said. The FTSE NAREIT All REIT Index outpaced the S&P 500, DJIA and Russell 2000 indexes in May by returning 2.34 percent. A year-to-date return exceeding 6.5 percent well outpaced broader markets.

“Real estate market fundamentals are healthy, and REITs continue to outperform broader markets this year,” Persin said. “Looking forward, we will be watching for a potential increase in the interest rate in mid-June and its effect on the REIT market.”