Multi-Family REIT Update: Predicting Fundamental Improvement, Stable Ratings

By Christopher Wimmer, Moody's Investor Service

Induced by inexpensive capital and stronger property cash flows, multi-family REITs are expanding their development pipelines. Numerous macroeconomic, financial market and regulatory uncertainties remain, as well. Overall, we view events as strengthening multi-family REIT credit quality, although significant risks remain.

The consensus view among economists and analysts—and also multi-family REIT CEOs—is that the rental apartment sector is poised for growth given the present state of supply and demand. On the supply side, new construction starts and completions are at all-time lows thanks to the weak economy and the absence of lending to many developers. On the demand side, a growing population of likely tenants and the economic recovery will stoke the growth engine.

These forces for improvement in occupancies and rents would normally justify a positive bias to our rating outlook. Our view, however, is tempered by certain challenges. Induced by inexpensive capital and stronger property cash flows, multi-family REITs are expanding their development pipelines. Numerous macroeconomic, financial market and regulatory uncertainties remain, as well. Overall, we view events as strengthening multi-family REIT credit quality, although significant risks remain.

In our April commentary, Moody’s said that original multi-family REIT guidance for 2010 performance appeared conservative. Indeed, we now expect 2010 operational and financial results to come in meaningfully higher than those originally forecasted by the companies’ management teams early this year. Furthermore, while most of the downside risks we detailed are still present—a double-dip recession, a strong surge in home buying, or the loss of access to GSE capital—and the financial crisis continues to take a toll on banks and sovereigns, most of these threats are less imminent than they were six months ago.

Despite the sluggish recovery, certain markets are experiencing decent employment trends and decreasing homeownership, which has pushed up occupancies and rents to near their prior peak levels in 2007 and 2008. These increases in turn have led to improvements in cash flow generated by multi-family properties. The average occupancy for multi-family REITs rated by Moody’s improved to 95.7 percent in the third quarter of 2010 from 94.7 percent in the fourth quarter of 2009 and the first quarter of 2010. As well, the year-over-year same-store NOI improved to -0.3 percent from -7.7 percent in the fourth quarter of 2009.

Over the last year, most of our rating actions have been affirmations and, with few exceptions, we expect this trend to continue. With respect to underlying fundamentals, we believe that the sector touched bottom early this year and is experiencing what is increasingly pointing to being a sustained period of strong improvement. Combined with ample capital access, low interest rates and balance-sheet discipline, the improvement gives Moody’s confidence in our ratings for the multi-family sector despite the REITs’ increasing biases for development and the remaining uncertainties in the capital markets and the economy.