Moody’s: Stability, Possible Upswing in the Cards for Industrial REITs

By Philip Kibel, Senior Vice President, Moody's Investors Service

Moody's rating outlook for the industrial REITs is stable, although ratings could have some positive momentum over the next 12 to 18 months.

By Philip Kibel,
Senior Vice President, Moody’s Investors Service

Moody’s rating outlook for the industrial REITs is stable, although ratings could have some positive momentum over the next 12 to 18 months.

Industrial real estate fundamentals are starting to see a recovery, albeit very slowly. Net absorption is turning slightly positive, occupancy is improving, same store net-operating-income growth is either flat (slightly positive) or less negative than in previous quarters, and rent roll-downs are smaller than in previous quarters. There has also been a dearth of new industrial real estate development, which is a plus. In all, two of the three REITs that Moody’s rates have stable outlooks, while the remainder has a positive outlook.

Moody’s expects credit metrics for the rated industrial REITs to continue to improve throughout 2011; they were slightly better for the first quarter of 2011 versus 1Q10 and year-end 2010. Rated industrial REITs still continue to have large unencumbered portfolios with good quality assets and modest on-balance-sheet secured debt levels. In addition, the tenant profile of most rated industrial REITs’ continues to show solid credit quality as well as good diversification by industry and type.

Key credit considerations for the industrial REITs at this time include their liquidity (availability on their lines of credit and cash on hand), the level and quality of core same-store NOI (which continued to deteriorate in the first quarter of 2011, albeit at a much slower rate than in the same period last year) and on-going pressure on rental rates. Meaningful leasing is still necessary to stabilize current development pipelines. A second source of some rating pressure is some large debt maturities, including fund and JV debt, from 2012 through 2014.

Core operations will take center stage for the rest of 2011 and in 2012 now that the REITs have taken care of their immediate liquidity needs and improved their balance sheets. Moody’s expects that by year-end 2011 most of the rated industrial REITs’ non-core fee income should be non-existent. Non-core income includes that generated from JV and funds businesses, gains from assets divestitures or land sales, and merchant building activities. Thus, those REITs that strayed farthest from their core buy-and-hold strategy have had to make the greatest adjustments to their liquidity needs and balance sheets in order to right the ship. Moody’s does acknowledge that the largest rated industrial property-focused REITs have made substantial progress in these areas.

On the economic front, Moody’s anticipates industrial real estate fundamentals will continue to face headwinds, but at a level reduced from a year ago, and stabilizing over the next 12 to 18 months. Most rated industrial REITs can expect their portfolio occupancies to flatten or modestly increase, with clear improvements coming by the end of 2012. However, the pace of the continued recovery is highly reliant on the strength of the broader economy.