Fitch Ratings published its 2011 outlook for U.S. equity REITs, and in my opinion it's a balanced and very carefully considered assessment of both the opportunities and the concerns heading into the New Year. Stock investors have to bear in mind that Fitch is concerned with the credit quality of REIT-issued debt, not with stock returns (appreciation or dividends). Still, what's good (or bad) for debtholders is generally what's good (or bad) for stockholders, too.
Overall, Fitch expects
Continued strong capital markets access, continued de-risking of issuers' balance sheets and strategies, relatively unchanged coverage metrics, and a strengthening asset sales environment.
The stable outlook also reflects the strong liquidity position for many REITs, as many issuers have accessed the capital market to repay or refinance near-term indebtedness.
Improved liquidity has enabled many companies to have the flexibility to pursue acquisitions without affecting rating levels. Fitch expects that REIT acquisition volume will increase in 2011, given that asset prices are still well below peak valuation, combined with significant secured debt maturities over the next few years.
That is key: REITs are in a superior competitive position relative to many (most?) other real estate investors, partly because of their superior access to capital and partly because they didn't get themselves in trouble by both paying and borrowing too much to buy properties at the top of the market. As a result, the wave of debt maturities over the next few years - coupled with the end of "pretend and extend" - will give REITs a spectacular opportunity to pick up good assets at the bottom of the market, as Fitch notes (in its very careful writing style):
Fitch expects that the large majority of REIT property acquisitions will be from commercial real estate entities seeking to delever their balance sheets and improve liquidity, as opposed to those companies looking to optimize their portfolios by selling lower quality or distressed assets. The commercial real estate transaction market is improving, due in large part to increased secured lending activity and more recent transactions by which valuation can be triangulated. A more robust transaction market may emerge to the extent that commercial banks seek to reduce their commercial real estate exposure by electing to monetize parts of their mortgage loan portfolios through note sales, discounted loan payoffs, or foreclosure actions, as opposed to extending loans beyond their initial stated maturity. In addition, CMBS special servicers may seek to market more assets serving as collateral for securitized mortgages, further improving the transaction market and opportunities for REITs to acquire assets.
Of course, Fitch maintains a typically conservative recognition of the possible downside:
Despite indications of an improving U.S. economy, relevant commercial real estate demand indicators, particularly employment growth, will not likely materialize until 2011. Given this lag effect, Fitch expects elevated U.S. unemployment levels and household deleveraging to continue to have a negative effect on REIT property operating fundamentals throughout 2011 for most sectors.
Improvements in the economy and sustained job growth may spur demand for commercial real estate space, increase occupancies and begin to stabilize rental rates across the sector, all of which are drivers of commercial real estate fundamentals. However, the positive effects of a stabilizing economy on a wide-scale basis have yet to be felt as the economic recovery is still in its early stages, and property fundamentals typically lag the economy.
Overall, I'd say it's a good primer regarding the factors that have driven the REIT recovery over the last 21 months and that will likely continue to drive REIT returns over the next several years.
Additional disclosure: Author is long Vanguard REIT Index Fund and ING Real Estate Fund.
Disclaimer: The opinions expressed in this post are my own and do not necessarily reflect those of the National Association of Real Estate Investment Trusts ((NAREIT)). Neither I nor NAREIT are acting as an investment advisor, investment fiduciary, broker, dealer or other market participant, nor is any offer or solicitation to buy or sell any security investment being made. This information is solely educational in nature and not intended to serve as the primary basis for any investment decision.