High Leverage May Lead Moody's to Downgrade Some REITs

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Differences in leverage as measured by the current market value of a real estate portfolio versus its book value may lead Moody’s to consider a small number of rating downgrades among U.S. REITs. In a new report, Moody’s says it has identified a number of REITs across the major REIT sectors whose leverage based on market value exceeds their leverage based on book value by a meaningful amount.

For the first time in several years, REIT portfolio book values for several issuers exceed their market values by a significant margin – Moody’s Vice President Chris Wimmer.

These gaps are likely to grow as capitalization rates, or cap rates, continue to rise and property cash flows continue to fall during the current recession and commercial real estate markets approach the bottom of the cycle over the next several quarters, says Moody’s.

A core part of Moody’s rating methodology for REITs, leverage measures that use market-based valuations of a REIT portfolio are increasingly relevant to REIT ratings, given current conditions. Moody’s primary tool for capturing this trend is the Market Value Leverage Analysis, or MVLA.

The new Moody’s report estimates market value leverage for the four major REIT sectors — industrial, multifamily, office and retail.

According to MVLA, seven issuers across the four sectors have differences in leverage that are over 20%. Two of those are candidates for a one notch downgrade and are currently on negative outlook.

For details see US REITs: Moody’s Market Value Leverage Analysis.