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Investments

REITs gain traction

Sector expected to withstand interest rate spikes

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Although the economy will likely expand at a slower pace than initially forecasted for the year, real estate investment trusts continue to feed off positive housing data, analysts say.

North American REITs and real estate operating companies should maintain stable ratings for 2013 and 2014, Standard & Poor’s Rating Services contends in a new report.

"Our expectation for a continued gradual recovery in the economy, combined with our belief that modest growth in GDP, employment and consumer spending will drive continued occupancy and rent improvements, support this outlook," explained S&P’s Rating Services real estate director George Skoufis.

Any ratings momentum is likely to have a positive bias on steady occupancy and rental rate gains given the fact that roughly 13% of REIT rates currently have positive outlooks, S&P noted.

Additionally, REITs continue to have solid access to capital markets, despite the rise in interest rates.

For instance debt and preferred issuance has amounted to roughly $14 billion for the year.

Despite the effects of sequestration and higher income taxes, key economic indicators such as commercial construction and consumer trends will be meaningful drivers for investors.

S&P expects real commercial construction to decrease 0.9% this year and then reverse course and grow 4.7% in 2014.

Furthermore, the consumer sentiment index is improving and is expected to reach 81.7 in 2013 and 85.9 in 2014 on a scale of 100, S&P said.

The two biggest factors playing against REITs are rising interest rates and the concurrent pullback in stock prices.

"Higher interest rates could continue to be a near-term headwind. However, we believe that the benefits to real estate demand trends of sustainable improvements in the economy and job market should outweigh this concern," explained Neuberger Berman Real Estate Securities Group co-portfolio managers Brian Jones and Steve Shigekawa.

They added, "REIT fundamentals should show further improvement as the year progresses, which would support cash flow and dividend growth."

Meanwhile, S&P analysts believe that real estate market capitalization rates will remain steady — particularly for better quality assets — providing some support for stability in property values.

"We expect improved cash flow generation and continued attractive refinancing opportunities to offset the dilutive effect of asset recycling and resume development activity," Skoufis said.

He concluded, "We believe the housing recovery under way has benefited certain REITs focused on retail/distribution and some office segments. Thus far, it appears rental household growth is keeping pace with new apartment supply in most markets."

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