If anyone had told us a year ago that Fitch would at least attempt to be a voice of reason, while Merrill Lynch, which has gotten destroyed on real estate, would be a CRE permabull, we would have punched them in the face.
Alas, this seems to have become the case. While readers are all to aware of Zero Hedge's coverage of the Merrill REIT team's follies in "analysis land", a Fitch piece from last week has some surprisingly insightful commentary on REIT. In a report titled "U.S. Equity REIT Liquidity Update: Hold the Applause" the rating agency paints a much more detailed and credible picture than i) expected and ii) than the 20 brand new analysts at ML/BofA could come up with.
From the report:
Challenges remain, including:
- Tenuous financing available across the capital markets.
- Deteriorating performance in commercial real estate and the sizable overhang of debt maturities for equity REITs looming in 2011.
- Limited visibility regarding net operating income capitalization rates, which continues to stress commercial property values constraining the magnitude of institutional investor-secured debt lending volume.
Also included is a pretty extensive laundry list for all the companies out there who still have not used ML's magical stock underwriting services.
- Likely Reduced Revolving Credit Facility Commitments: Most REITs’ unsecured revolving credit facilities mature beyond Dec. 31, 2010. Within the tables on page 4?7, Fitch has reduced the borrowing capacity under revolving lines of credit by 33% for REITs that have revolving lines of credit that mature before Dec. 31, 2010 after taking into account extension options for illustrative purposes. This capacity reduction reflects a “what if” scenario for certain REITs as revolving credit facility maturities approach. While a limited number of REITs have either recently extended or increased the borrowing capacity under such revolving facilities, Fitch believes that many of these facilities will be reduced in size. For its rated universe, Fitch does not believe that many of these facilities will be converted from unsecured to secured given the strong lending relationships most of theseissuers have with their banking groups. That said, for weaker issuers across the equity REIT universe, the prevalence of secured credit facilities will likely increase given banks’ limited capital and concerns regarding borrower credit.
- Limited Unsecured Bond Issuances: Recent unsecured bond issuances do not constitute a panacea for REIT liquidity, as the unsecured bond market remains unattractive to most equity REITs. Credit spreads have tightened, but indicative pricing across the industry remains unattractive to many companies, particularly relative to secured debt.
- Near-Dormant CMBS Market: Liquidity remains weak in certain areas such as secured funding in the commercial mortgage-backed securities (CMBS) market. Although the inclusion of legacy CMBS for eligibility under the Federal Reserve’s Term Asset Backed Securities Loan Facility beginning in July may play a role in the restoration of investor confidence in commercial real estate, CMBS issuance volumes are highly unlikely to be restored to pre-2008 levels.
- Reduced Bond Tender Activity: While $2.8 billion in bond tender offers executed year to date have allowed companies to reduce uses of liquidity, such transactions have been a byproduct of bonds trading at discounts to par, which have included securities issued by REITs with below-investment-grade issuer default ratings (IDRs). Spreads have tightened recently, shrinking the arbitrage opportunity bond tenders present.
- Uncertain Common Equity Issuance: With $12.4 billion in new equity raised year to date by REITs, the re-equitization wave has enabled REITs to strengthen their capital bases. However, investor demand may be driven in part by low share prices relative to net asset values, while share prices of certain other equity REITs are such that prospective equity issuances are unlikely.
And some more good insight:
Encouraging Signs Are Not Ubiquitous
Year to date, 18 REITs have launched tender offers to repurchase approximately $7.0 billion of outstanding bonds and have tendered for approximately $3.1 billion of securities. Many REITs that have launched tender offers have IDRs in the ‘BBB’ rating category. Fitch’s ratings for REITs that have launched tender offers range widely, from Public Storage (which has an IDR of ‘A’ by Fitch, with a Stable Rating Outlook) to Centro NP LLC (which has an IDR of ‘CCC’ by Fitch, with a Negative Rating Outlook). Fitch views consummated tender offers as encouraging in that they demonstrate REITs’ ability to reduce their future funding obligations and temporarily reduce cash interest expense by utilizing low-cost unsecured lines of credit. Such tender offers have been affected by REITs with capacity under their credit facilities. REITs that have not executed tender offers may have limited liquidity to launch tender offers, while others have shorter tem funding needs to address.
Similarly, the equity issuance wave has been encouraging for REIT liquidity, as year to date, 38 REITs have raised an aggregate of approximately $12.8 billion in proceeds. With certain companies reluctant to issue at these prices
It will be interesting what everyone will be saying about REITs in a few months when the impacts of the recent hotel bankruptcies start reverberating through the system, and the full scale of the massive overhang of excess inventory in major metropolitan areas become fully flushed out.