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December 19, 2012

Will Fiscal Cliff Derail U.S. Equity REITs in 2013–All Signs Point to ‘No’

By Steven Marks, Head of U.S. REITs, Fitch Ratings

Vibrant capital markets and lukewarm property fundamentals augur for a continued stable outlook for U.S. equity REITs in 2013. One key area, however, that has potentially significant impact and bears close watch will be the looming fiscal cliff.

The fiscal cliff is a concern to both the real economy and property-level fundamentals. Fiscal cliff fallout would erode consumer and business confidence. A fiscal cliff-induced recession, were it to take place, would hurt apartment, office and retail landlords the most. Longer-term leases should insulate most companies from an immediate slowdown in the economy, but rent levels would likely decline.

With respect to the looming fiscal cliff, the likely scenario is that the implied tax increases and spending cuts will be avoided or at least temporarily deferred. However, the lack of a credible deficit-reduction plan and uncertainty over federal tax and spending could continue to erode consumer and business confidence. This in turn could adversely affect the REIT sector’s Stable Outlook. That said, Fitch thinks it is unlikely that there would be wholesale downgrades because most equity REITs have ample cushion in their current ratings.

Absent fallout from the fiscal cliff, Fitch expects modest growth in GDP in 2013. This growth will contribute to slightly positive property-level fundamentals, with multifamily REITs on the most solid ground. Retail, industrial and central business district office REITs should have modestly positive same-store net operating income growth. The suburban office sector will continue to face challenges in maintaining net operating income.

Fitch expects issuers will continue to have liberal access to historically low-cost debt. Leverage, long a concern for Fitch with respect to equity REITs is likely to remain elevated. Fitch expects REITs to fully move away from reducing debt and instead use proceeds from follow-on common equity offerings for development and other growth opportunities. Fitch does not envision meaningful change in REIT acquisition volumes in 2013 compared to this year.