Specialty REITs

By Maria Maslovsky, Assistant Vice President & Analyst for Commercial Real Estate Finance, Moody’s Investors Service: The variety of property-related companies choosing to become REITs has greatly expanded in recent years.

The variety of propertyrelated companies choosing to become REITs has greatly expanded in recent years.  Moody’s maintains ratings on datacenter, self-storage and prison REITs, as well as on a cell tower REIT.  Recently a major casino player announced a plan for an OpCo/PropCo split and a REIT conversion for the PropCo.  All of these businesses are looking to take advantage of the tax savings and easier access to the equity markets that REITs have, as well their often favorable stock valuations. 

Each category of specialty REITs brings unique features key to its analysis within the framework of Moody’s REIT rating methodology.  One of the unifying themes for specialty REITs is the limited alternative use for their assets as compared to the traditional property sectors.  Moody’s considers these assetquality issues carefully and incorporates them into its ratings.

Fueled by unrelenting demand for data both from consumers and businesses, the datacenter space has grown tremendously in recent years.  The proliferation of smart phones and tablets, in addition to conventional computers, as well as the mounting number of available applications (particularly games and video), support the sustainability of demand for computing power, at least in the medium term.  Moody’s carefully considers the strong favorable demand trends for datacenters and weighs them against the potential for oversupply.  Moody’s rates three datacenter REITs: Digital Realty Trust (Baa2/stable), DuPont Fabros (Ba1/stable) and CyrusOne (B1/stable).  

Moody’s rates one cell tower REIT, American Tower (Baa3/stable), which also benefits from the strong demand for data transmission that is buoying the performance of datacenters, although its customers are primarily the large wireless carriers.  Two key considerations in Moody’s approach to rating American Tower include its aggressive acquisition stance globally, as well as the limitations regulatory and physical constraints place on additional supply.

The selfstorage sector is currently benefitting from limited new supply as a result of lender retrenchment, although Moody’s believes new product will come on line in the medium term.  The self-storage industry is dominated by four public REITs that bring to bear their scale and cost of capital advantage to fund large advertising programs, particularly use of internet media.  Still, the space remains very fragmented, with a lot of small private players, due primarily to the simplicity of operations and relatively low break-even occupancy (in the 70 percent range).  Positively, self-storage REITs proved resilient in the most recent downturn and, to a degree countercyclical in a housing-driven recession.  Moody’s rates two self-storage REITs, Public Storage ((P) A2/stable), the leader in the industry by far, and CubeSmart (Baa3/stable). Public Storage has the highest rating of any REIT in North America that Moody’s rates.

Prison REITs operate private correctional facilities under contract from either a state or the federal government.  Given the strained budgets and current overcrowding in many federal and some state prisons, the demand for private corrections operators is strong.  The key risks for this sector include negative public sentiment and headline risk, as well as the ability of the governmental entities to cancel contracts with relatively short notice.  Still, the two prison REITs rated by Moody’s, Corrections Corporation of America (Ba1/positive, senior unsecured debt) and Geo Group (B1/positive, senior unsecured debt), have performed well in recent years.