Rating M-F REITs
- Apr 02, 2014
Our outlook for the multi-family real estate investment trust sector is stable for both fundamentals and ratings. Cash flow growth will be solid in 2014, though not as strong as in recent years. Development pipelines are expanding, but continue to align with demand growth. Credit profiles are improving, especially as more issuers adopt the senior unsecured borrowing model as opposed to Fannie Mae and Freddie Mac capital. We rate 10 multi-family REITs; two enjoy positive rating outlooks, and all others have stable outlooks.
There were a number of mergers and acquisitions in 2013. AvalonBay Communities, Inc. and Equity Residential closed on their joint purchase of the more than 45,000-unit Archstone portfolio. In addition, Mid-America Apartment Communities, Inc. purchased Colonial Properties Trust, and Essex Property Trust, Inc. acquired BRE Properties, Inc. In our opinion, none of the transactions pose significant risks to credit quality, and we have affirmed each of the surviving entities’ ratings.
There have been renewed efforts to reform Fannie Mae and Freddie Mac, both significant supporters of apartment finance and lenders to multi-family REITs. The outcome of these proposals, some of which resemble earlier ones, is difficult to handicap through the legislative process, especially as we do not know how upcoming elections will change the makeup of the U.S. Senate. The government will likely phase in the ultimate resolution over a number of years. Absent the government-sponsored entities (GSEs) or a substitute that provides similar capital and liquidity, we would expect multi-family REITs to maintain leverage levels closer to those of other types of REITs.
Property-level cash flow, in the form of same-store net operating income (SS NOI), continues to moderate from the strong levels of 2011 and 2012. In 2013, SS NOI for the multi-family REITs that we rate grew 4.7 percent. Given high occupancy rates and continuing rental rate improvement in most markets, the average growth forecast is 3.8 percent in 2014. Although this would be the lowest rate in four years, it is still very respectable from a historical perspective.
Improving fundamentals and cash flows in the apartment sector typically lead to an increase in new multi-family construction, but this has not occurred in the current cycle because of tighter lending conditions. Generally, a strong balance sheet (i.e., REITs) has been a precursor to break ground for new multi-family construction, whereas apartment developers without balance sheets and more limited capital access have been less prevalent in this recovery. Moreover, the drop off in completions as a result of the recession was especially severe and developers argue that a backfill is required in order to meet the increasing numbers of tenants emerging with the pickup in the economy.