Fitch: US REIT Credit Weakening at the Margin
However, property level fundamentals remain strong for most property types, and companies are generally well capitalized; both leverage and fixed-charge coverage compare favorably with their respective long-term averages.
Companies are increasingly focusing on new development to drive earnings and net asset value (NAV) growth in the context of competitive acquisition market pricing due to strong demand for stabilized commercial real estate assets from domestic and foreign institutional investors. Strong property fundamentals and successful recent projects have also caused some companies to moderately increase their appetites for speculative development projects.
Development pipelines for the U.S. equity REIT sector comprised 5.2% of gross assets at June 30, 2015, compared with 4.8% a year earlier. The comparable unfunded components of development pipelines relative to gross assets were 2.5% and 2.0%, respectively. REIT development pipelines peaked at 7.6% of gross assets during the last cycle in 2007 (3.6% unfunded).
Discounted equity valuations have resulted in weaker financial flexibility for the sector. REIT stocks have sold off since mid-January, primarily due to rising interest rate concerns. The average REIT trades at a 16% discount to NAV, which limits the ability to fund external investments on a leverage-neutral basis. Regulatory taxable income distribution requirements limit the ability of REITs to retain internally generated cash, making the sector reliant on consistent capital markets access.
Outstanding revolving credit facility balances at the end of the period were at their highest levels since December 2008, and median utilization percentages increased to 22% as of June 30, 2015, compared with a recent low of 13.6% at YE13. Property sales can provide an alternative source of capital; however, many REITs are focused on selling non-core assets in secondary markets, which could be hindered by the recent increase in CMBS spreads. Also, many REITs have or are considering repurchasing shares given the public market discount relative to private market values.
Discounted equity valuations are mostly a sectorwide issue; however, Fitch has also observed greater distinction in unsecured public bond market access among issuers. Less seasoned issuers and those with portfolios concentrated in secondary markets and/or non-favored property types (i.e. Class B malls and specialty properties) have seen marked increases in new issuance spreads.
Moreover, no issuer has completed an inaugural public bond offering since March 2015. Potential inaugural issuers unable or unwilling to access the public bond markets have accessed other sources of capital, issuing private placement bonds and the bank term loan market to repay outstanding balances on revolving credit facilities and fund growth.
Due to investor expectations of rising interest rates, preferred stock issuance year to date accounted for the lowest percentage of total capital issuance in the past 10 years, other than 2009, when no preferred stock was issued.
For more information, see the REIT dashboards listed above and below, available on Fitch's web site at www.fitchratings.com.