In its 2011 Outlook for U.S. equity REITs, Fitch Ratings maintains a "stable" outlook for office REITs, although it points out a significant difference in operating fundamentals between CBD and suburban office properties.
That is a critical factor: even in a time of general weakness in operating fundamentals, that doesn't mean equally weak fundamentals for everybody; REITs historically have provided much stronger returns to their investors than have other real estate investment managers, and a good part of the reason (in my opinion) is simply that they are better at managing their assets.Fitch's office REIT outlook for 2011 is stable based on the sector's continued access to capital and improvements in liquidity. Further, improved balance sheets to some extent will offset challenging, but moderating, property market fundamentals.
That said, there is a clear bifurcation in property fundamentals between CBD and suburban office. Net effective rents and occupancy levels in most CBD markets appear to be bottoming, whereas properties in most suburban markets face continued weakness.
Fitch's outlook for office property market fundamentals is mixed, driven by high vacancy rates and a protracted high unemployment rate. Office fundamentals are expected to inflect positively in 2011 with positive rent growth and a vacancy rate decline according to Property & Portfolio Research (NYSE:PPR). However, despite these improvements, NOI is expected to fall. On the positive side, construction remains muted.
While the operating environment for office REITs remains challenging, most office REITs will fare better than the market average due to higher-quality portfolios and strong management and leasing teams, thereby allowing REITs to benefit from tenants trading up to better space. As of 9/30/10, Fitch's universe of office REITs had average occupancy or 90.8%, compared to 80.5% for the PPR 54-market average.
In terms of access to capital,The stable outlook is also supported by the flexibility public REITs have due to their multiple sources of liquidity to be acquisitive nad fund tenant improvements and leasing commissions to fill vacant space, compared to more financial restricted private players.
The publicly traded office REITs (from largest to smallest) are Boston Properties (NYSE:BXP), SL Green Realty (NYSE:SLG), Alexandria Real Estate Equities (NYSE:ARE), Piedmont Office Realty Trust (NYSE:PDM), Mack-Cali Realty (NYSE:CLI), BioMed Realty Trust (NYSE:BMR), Corporate Office Properties Trust (NYSE:OFC), Highwoods Properties (NYSE:HIW), Douglas Emmett (NYSE:DEI), CommonWealth REIT (NYSE:CWH), Kilroy Realty (NYSE:KRC), Brandywine Realty Trust (NYSE:BDN), Government Properties Income Trust (NYSE:GOV), Franklin Street Properties (NYSEMKT:FSP), Parkway Properties (NYSE:PKY), Hudson Pacific Properties (NYSE:HPP), MPG Office Trust (NYSE:MPG), and Pacific Office Properties Trust (PCE).The debt and equity markets remain open for REITs in general, and office companies have taken advantage of this to improve liquidity and flexibility by issuing low-cost, longer term debt and tendering for near-term maturities, improving debt maturity schedules.
Fitch would turn more positive on the sector if property fundamentals improve materially over the near term. Conversely, should property fundamentals materially deteriorate further, issuers increase leverage or the capital markets become inhospitable, Fitch would take a more negative view on the sector.
Nine REITs are in Fitch's coverage universe: BXP, SLG, CLI, HIW, and BDN plus Liberty Property Trust (LRY) and PS Business Parks (NYSE:PSB), which NAREIT considers "mixed" office/industrial REITs; Vornado Realty Trust (NYSE:VNO), which NAREIT considers a diversified REIT; and Reckson Operating Partnership LP.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Author is long Vanguard REIT Index Fund and ING Real Estate Fund.