Moody’s Investors Service View on US Multifamily REITs

US multifamily REITs’ net operating income growth will continue to decelerate on weakening fundamentals, notes Moody's Investors Service Assistant Vice President Griselda Bisono.

griselda-bisono,-moodysIn Moody’s opinion, the operating performance of US multifamily REITs will continue to decelerate this year. We expect net operating income (NOI) growth for multifamily REITs that we rate to slow to about 2.7 percent by the end of 2017, down from 5.5 percent growth at year-end 2016. The deceleration in NOI growth reflects increased apartment supply, coupled with a reduction in job growth, which is cutting into the REITs’ ability to raise rents. The deceleration in NOI growth follows a prolonged period of above-average growth from 2011 to 2015, when the REITs benefited significantly from limited supply and strong demand following the 2007 to 2009 recession.

The 2011 to 2015 growth reinforced the attractiveness of the multifamily sector as an asset class for investors. The multifamily transaction market has been very active over the past several years, leading to much development and oversupply of apartments in some markets. We expect apartment completions will likely peak this year, but we do not expect a full absorption of supply until at least 2018. In some markets, such as New York City, Seattle and Dallas, absorption could take longer, owing to continued deceleration in job growth. We expect improvement in employment growth in Houston, mainly in non-energy related sectors, which should help absorb some of the new apartment units developed in the past year. The health care and hospitality sectors are leading all markets in terms of job growth, ahead of finance and technology. REITs with heavy exposure to urban coastal markets have many tenants who work in the finance and technology sectors. As a result, these REITs might have weaker operating results in those markets.

Nevertheless, long-term fundamentals continue to favor renting versus owning. The high cost of homeownership and the lifestyle choices of millennials, the target demographic of multifamily REITs, will result in continued consistent demand for apartment units. Job growth was positive from 2009 to 2015, which helped spur demand for housing generally. Millennials are more likely to rent versus own, a reflection of lifestyle choices such as delayed marriage and having children later in life. The high cost of owning a home and the slow recovery of the US single-family housing market also will support the rental sector over the long term. Lending standards remain stringent and make it difficult for buyers to obtain financing. As a result, the homeownership rate hit its lowest level in nearly 40 years, a rate of 63.1 percent, as of the end of 2016.

Despite weaker fundamentals, multifamily REITs have a strong credit profile with low leverage and ample liquidity. Secured debt levels have declined significantly to below 15 percent for the rated multifamily REITs compared with five years ago when secured debt levels exceeded 25 percent, a result of companies tapping the unsecured debt market at a lower cost of capital. Fixed-charge coverage levels are strong and approaching 4.5x, with REITs having taken advantage of a low-interest-rate environment. Development pipelines are at relatively low levels, which reduce construction and leasing risk. Finally, liquidity profiles remain strong, with plenty of dry powder to fund debt maturities, capital spending, development and acquisitions. Thus, we expect any operating disruptions to have minimal effect on the credit quality of multifamily REITs.

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