The News: Declining Fundamentals Challenge REITs

Job losses are decreasing demand for apartments, but multi-family REITs may have some long-term trends in its favor, according to a recent Moody’s Investors Service report. The ratings agency tracks nine multi-family REITs, eight rated stable and one bearing a negative outlook. In the near term, these REITs are unlikely to face pressure from U.S. residents who are leaving their apartments to buy homes, owing to the fact that people do not want to buy assets that are falling in price, tough lending standards and the frightening employment picture.But multi-family REITs will face tremendous challenges from that same weak job market. During the last recession, earlier in this decade, unemployment peaked at 6 percent. During that downturn, the rated REITS saw 11 consecutive quarters of contracting net operating income, the largest decline, 9 percent, coming in the first quarter of 2003. During the previous downturn, the cumulative drop in property cash flow for the rated multi-family REITs was 8.5 percent peak-to-trough, which translated to an EBITDA decline of 14.5 percent. If, as some economists predict, unemployment reaches 10 percent in this recession, property cash flow will decline 14.2 percent, with a corresponding EBITDA decline of 24 percent. That could mean that some of these REITs could be downgraded, “multi-notch in some cases,” according to Moody’s.The rated REITs have also sharply cut their development activities, and Moody’s sees that as a plus. “We acknowledge that new development can be an attractive avenue for growth, especially during periods marked by low cap rates.” However, Moody’s believes that there are more important uses of capital, such as shoring up liquidity and maximizing balance-sheet flexibility.The two- to three-year picture is brighter than that for the short term. January’s seasonally adjusted annualized pace of new multi-family starts for buildings encompassing at least five units was 118,000, the lowest since January 1994. Also, Generation Y members, whose births peaked in 1990, are now entering the 18 to 25 age range when the propensity to rent is the greatest. That means there could be a record number of renters looking for apartments in a supply-constrained market, the report concluded.