U.S. Equity REITs & Industrials – An Exercise in Contrasts

By Sean Pattap, Senior Director, U.S. REIT Group, Fitch Ratings: While there are similarities between REITs and non-REIT corporations, the differences exceed similarities and deserve consideration for fixed-income investors.

U.S. equity REITs are corporate bond issuers that elect a certain tax status and have unique investment parameters, distribution requirements and liquidity needs. While there are similarities between REITs and non-REIT corporations, the differences exceed similarities and deserve consideration for fixed-income investors.                   

One notable difference is tax implications. A REIT is organized as a corporation or business trust, but REITs have greater tax efficiencies than non-REIT corporations. Corporations that have not elected REIT status are subject to federal income tax. By contrast, a company that elects REIT tax status is exempt from paying tax on the portion of income paid as dividends to shareholders.

Another difference relates to financial flexibility and distributions. A REIT must distribute at least 90 percent  of taxable income as dividends to shareholders to retain REIT status. By contrast, non-REIT corporations have significant flexibility in establishing the level of distributions. Certain industrial issuers have increasingly become active in special dividends and share buybacks, but companies that have been willing to have their credit downgraded through shareholder-friendly activities have been relatively few in number, despite the availability of very low-cost, long-term debt.

While both REIT and industrial ratings center around ‘BBB’, the spectrum of credit ratings for REITs and non-REIT corporations also varies. Non-REIT corporate credit ratings range from ‘AAA’ (Johnson & Johnson) to ‘D’ (AMR Corp.). The bell curve is much tighter for Fitch-rated equity REITs, which are as high as ‘A+’ (Public Storage) and as low as ‘BB-’ (Brixmor). 

REITs would likely be considered less attractive stock investments if they utilized minimal levels of leverage commensurate with higher rating levels, given the dividend yield and return expectations of equity investors. The long-term cash-retention limitations placed on REITs may also limit the extent to which equity REITs could achieve higher rating levels, as REITs rely on consistent access to the capital markets.