NEW YORK CITY-For many real estate investment trusts, the outlook for new development and construction has been dim—and the pool of new projects is continuing to dry up. According to new research from Fitch Ratings, the publicly-traded REIT development pipeline is currently 55% smaller than its peak level in 2007, a sign that more companies are seeking to acquire existing properties as opposed to building them ground-up.
“By and large, companies have not ramped up development pipelines,” Steven Marks, managing director at Fitch Ratings, tells GlobeSt.com. “It is really growth via acquisitions and organic cash flows from existing portfolios.”
The trend, highlighted in a new Fitch report entitled “US Equity REITs Recalibrate Development for New Normal,” found that after peaking $34 billion in the fourth quarter of 2007, development programs decreased sharply over the next 2.5 years due to a “significant demand slowdown, combined with most REITs focus on preserving liquidity and reducing leverage.” The report says total development pipelines represented only 2.7% of total undepreciated assets as of March 31, 2012, down from a peak of 7.6% as of 2007, indicating that development exposure remains “fairly muted” and “not a meaningful” credit risk.
“During that period, especially during 2009, REITs were more focused on maintaining liquidity and de-risking their balance sheets,” Marks says. “Part of that effort was to reduce development, and in particular, speculative development.”
One bright spot is multifamily. According to Fitch, the sector has the strongest property level fundamentals, making up 35% of the total REIT development pipeline. And due to the supply/demand imbalance, Marks says the trend is “definitely favoring” property owners and developers.
“The underlying property performance over the last year and a half has been fantastic,” he says. “That has encouraged multifamily owners to look to grow their portfolios. The second driver is that it is very difficult for many of the multifamily REITs to grow via acquisition because cap rates have been driven down and values have been driven so high on multifamily product that it has come down to a build versus buy decision. Many multifamily REITs are finding it advantageous to develop as opposed to finding new acquisitions.”
In addition, many REITs in other sectors – like industrial – have limited their development primarily to build-to-suit projects. “Industrial is significantly down from the peak,” Marks says. “Every sector is down from the peak and industrial had the highest development exposure, so the decline has been most notable for industrial. But there is a little bit of development. One of the things that is happening in industrial development is that there is a lot more build-to-suit activity. There is very little speculative development, only in certain pockets of the country.”
The report also found that pipeline commitments generally follow GDP. Over the past 10 years, Fitch research shows that unfunded development has tracked US GDP growth with a moderately strong correlation, indicating that REIT development strategies are countercyclical. “Companies were reducing their development exposure as the economy was softening and has generally increased in lockstep with modest GDP gains,” Marks says.
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