Industrial REITs Still on the Negative Outlook Plank

By Steven Marks, Fitch Ratings
Industrial REITs are more highly levered than any other REIT property type. Despite steps to curb leverage, levels remain high and will remain so without added de-leveraging initiatives.

While a modest rebound in occupancy is in the cards thanks to limited new supply, the rating outlook for industrial REITs remains negative. The primary credit constraint is leverage.

Industrial REITs are more highly levered than any other REIT property type. Despite steps to curb leverage, levels remain high and will remain so without added de-leveraging initiatives. United States industrial REITs are also still struggling with warehouse property cash flows due to downward mark-to-market pricing on expiring leases.

Growth in industrial REITs’ same-store net operating income may not occur until after 2011 as landlord pricing power remains strained. Industrial properties are less directly tied to improvements in consumer confidence, such as multifamily and retail. As such, they may not rebound with the same magnitude. This means continued pressure for industrial REIT markets.

Offsetting the negative pressures to some extent are historically low construction levels for industrial properties, which should improve vacancy rates due to limited new supply. However, rising U.S. GDP and throughput of goods could spur space demand, possibly a precursor to fundamentals ultimately bottoming out.

Industrial REITs should benefit from earnings diversification including property and asset management fee income. Acquisition activity has also increased in the sector, which may allow many industrial REITs to monetize their portfolios. Also servicing as a positive is vastly improved capital markets access, with industrial REITs raising almost $2 billion in debt through first-half 2010 and continuing to raise equity to repay indebtedness, which is improving their liquidity profiles.

The main constraints, however, remain elevated leverage and unsecured debt covenant concerns, which means continued pressure on industrial REITs for the foreseeable future.