NEW YORK CITY—While retail REITs have gotten a fair amount of largely negative attention lately due to the accelerated pace of announced store closures and bankruptcies from distressed retailers, the noise surrounding the sector drowned out a quieter parade of solid performance in the first quarter from real estate trusts generally. S&P Global Ratings reported that REITs' Q1 results were generally in line with expectations, although they pointed to a trend of decelerating growth that S&P expects to continue for the balance of the year.
“We continue to expect stable credit quality and ratings cadence for the sector in 2017, and project NOI growth of 3.0% to 3.5% for our rated REIT universe,” according to an S&P report issued Tuesday. That's based in part on REITs' “favorable” access to the capital markets in the first five months of this year.
Overall, REITs raised 23% more capital through May of 2017 than in the first five months of 2016, according to S&P Global Market Intelligence. That equates to $19 billion of debt, $16 billion of common equity and $2 billon of preferred equity.
S&P-rated REITs raised about $10 billion of debt through May, with retail, specialty and health care among the largest debt issuers. As of June 13, the S&P investment-grade composite spread was narrower than both its one-year moving average of 177 basis points and the five-year moving average of 183 bps. This suggests that “REIT bonds remain in favor with investors despite the rising interest rate environment,” according to S&P.
The political gridlock in Washington, which has prevailed despite the Republican Party taking control of the White House and both houses of Congress, has potential impact on commercial real estate generally, and REITs are no exception. However, S&P notes that while potential changes to taxes, the fiscal budget, US trade, immigration or other policies “could create some pressure for certain REIT subsectors,” only modest tax cuts are likely, along with reduced regulation and a small infrastructure initiative over the next two years.
Sector performance varied among REITs during Q1. Industrial REITs posted the best same-store NOI growth during Q1 at 5.8%, followed by office and self-storage, each at 4.4%. Faring worst were regional mall REITs with 0.8%, while strip-center REITs posted better results during Q1, averaging 2.1% NOI growth.
Not only retail REITs were buffeted by the bad news in the sector. Although net lease REITs typically see low cash-flow volatility, S&P reports that this group of trusts faced more adversity in Q1 than they have in recent memory, stressed by increasing retailer troubles. In particular, Spirit Realty Capital reported a poor quarter, but “tenant concerns reverberated throughout the sector and caused significant stock price declines,” according to S&P.
The ratings agency says tenant concerns “may be slightly overblown,” since net lease REITs tend to focus more on service-oriented retailers—including restaurants, convenience stores, fitness centers and movie theaters—and less on traditional retailers, thereby implying that their tenants should face fewer disruptions from e-commerce growth. “That said, the cost of capital advantage that these REITs previously enjoyed has significantly narrowed, as many stock prices are trading near 18-month lows,” according to S&P's report.
“This is notable since the net lease REITs tend to be aggressive acquirers, and have historically funded this growth in a leverage-neutral manner,” the report states. “Our view is that most net lease will curtail their acquisition pursuits and will operate with leverage near current levels; however, we think leverage could increase at the REITs with more aggressive growth strategies.”
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Paul Bubny
Paul Bubny is managing editor of Real Estate Forum and GlobeSt.com. He has been reporting on business since 1988 and on commercial real estate since 2007. He is based at ALM Real Estate Media Group's offices in New York City.
