Office REITs Steer Clear of Weak Operating Environment

By Steven Marks, Fitch Ratings:
Office vacancies remain high, with a near-term peak likely, and the operating environment for office properties is unfavorable and figures to be for the foreseeable future. Despite these numerous credit negatives, Fitch Ratings' outlook for office REITs is stable. The primary reason is that most office REITs have fared better than the market generally due to higher-quality portfolios and strong management and leasing teams.

Office vacancies remain high, with a near-term peak likely, and the operating environment for office properties is unfavorable and figures to be for the foreseeable future. Despite these numerous credit negatives, Fitch Ratings’ outlook for office REITs is stable.

The primary reason is that most office REITs have fared better than the market generally due to higher-quality portfolios and strong management and leasing teams. And while vacancies are still trending higher, the pace has begun to slow due to fewer space give backs and modest increases in office-using employment

Additionally, while most office REITs reported same-store net operating declines last year, the average decline for the companies in question was a scant 1.1 percent, well below management forecasts for 2010.

Following a wave of equity and unsecured debt issuance last year, office REITs continue to access the unsecured bond market, raising well over $1 billion thus far in 2010.

A substantial rise in office-using employment will be necessary to reverse negative rent and same-store net operating income trends, not likely over the near term. But once a solid recovery in office using employment takes hold and shadow space is utilized, office REITs will be positioned for a strong recovery due to lower levels of new supply since development has slowed to a trickle. This bodes well for major office markets such as New York City and Washington, DC.

It should be noted that Fitch continues to project further deterioration property-level performance. Nonetheless, office REIT ratings will generally be stable due to measures taken by companies to strengthen their balance sheets, capitalization and liquidity over the past two years.