Recent Policy & Bond Market Developments a Plus for Global Equity REITs

By Steven Marks, Head of U.S. REITs at Fitch Ratings: Two recent developments have the potential to brighten the outlook for equity REITs in the U.S. and the EMEA region.

Two recent developments have the potential to brighten the outlook not just for equity REITs in the United States, but in the EMEA region as well.

Convertible bond issues have been coming to the EMEA market in recent months at low coupon rates. This is a benefit for EMEA REITs because they can cut overall funding costs. Major EMEA REITs are able to access debt capital at interest rates well below their existing average cost of finance. Moreover, in case of conversion to equity, loan-to-value leverage would mildly improve and dividends increase only moderately.

This prediction comes on the heels of another potentially positive development, this time on the U.S. policy front. The Federal Open Market Committee’s third round of quantitative easing (QE3), an expansion of ‘Operation Twist’, could have favorable implications for U.S. equity REITs.

QE3 could have a more meaningful impact on some REIT sectors versus others. If QE3 achieves the desired effect on the U.S. economy, equity REITs would benefit in the long term, approximately 12 to 24 months later. Ownership and long-term financing of commercial assets tie equity REITs closely to the general economy but with a lag, given that longer-term leases would need to mark to market over time. If QE3 keeps U.S. Treasury rates at their current levels or causes them to decline, borrowing costs for REITs would likely drop as well. Lower long-term rates could also entice investors to allocate capital to REITs, given their dividend yields and higher unsecured debt spreads relative to corporate borrowers.

REITs continue to demonstrate strong access to capital and improving property-level fundamentals. This is due primarily to only limited new supply placing pressure on rents. These positive elements are balanced by a slow economic recovery and potential eurozone headwinds that are slowing business decision-making.