Fitch: Equity Values, M&A, Covenants Focus of REIT Market

Macroeconomic and property sector themes are expected to define REIT credit trends in the near-to-medium term, according to Fitch Ratings. That view was also reinforced during the most recent NAREIT conference. We believe equity valuations and willingness to issue equity could govern whether companies can grow on a leverage-neutral basis. Meanwhile the expectation of continued REIT privatizations and the subsequent change-of-control (CoC) stalemate between issuers and investors will influence unsecured debt issuance volumes.

Market conditions are ripe for privatizations over the next few years. Low cost capital is plentiful and debt underwriting standards have loosened. With investment yields compressed globally, REITs do not need to trade at as wide of a discount to net asset value (NAV) or require significant growth for returns to meet go-private buyers' hurdles. Liquid capital markets and lower return requirements are likely to result in more transactions in our estimation.

The expectation for continued privatizations and Blackstone Property Partners' decision not to tender for the public bonds of Excel Trust (BBB-/Rating Watch Negative) after its acquisition announcement has led to a stalemate between issuers and investors surrounding CoC provisions. The non-tender caught investors by surprise, upending the belief that REIT bonds are protected from privatization. Tellingly, there has not been a public issuance by an inaugural REIT issuer since the announcement.

While volatility in Treasurys may be partially to blame for the absence of inaugural issuers since the announcement, Fitch believes there is also a CoC stalemate developing between issuers and investors, particularly regarding investors' apparent unwillingness to tighten spread expectations in exchange for CoC put language.

A key question heading in to 2Q15 earnings is whether equity values will deter issuance for the remainder of the year. While REITs are generally insulated from rising rates, upward rate moves remain a concern. The 10-year Treasury rate has risen to 2.50% at the start of the NAREIT conference from 1.68% at the end of January. Over the same period, REIT share prices declined by 10% and are now trading at a 6% discount to NAV from a 10% premium. Issuers have not seen a meaningful repricing in property values that would justify a share price decline from their perspective. Regardless as to whether the decline is justified based on asset prices, weakness generally could limit company appetites for equity issuance and possibly lead to marginally weaker credit metrics in the near-to-medium term.

The competitive environment for acquisitions, modestly positive growth in operating fundamentals, and the delayed benefits from development may further limit the feasibility of meeting investors' expectations for NAV and earnings growth per share on a leverage neutral basis. As a result, increased leverage and/or the share buyback siren song may prove to be too irresistible for some managements looking to tighten the NAV discount.