Bigger Doesn’t Always Mean Better for Equity REITs

By Stephen Boyd, Director, REITs, Fitch Ratings 

Size and seasoning are more likely to support than restrain U.S. equity REIT ratings, though there are certain instances where a company’s size can actually be a hindrance.

For instance, while size is often a positive rating attribute for larger REITs, Fitch does not reflexively consider it a credit negative for smaller REITs. In fact, smaller REITs can achieve investment-grade ratings to the extent that Fitch anticipates additional growth in unencumbered portfolios, improved credit metrics and enhanced access to unsecured debt capital. Conversely, a larger size does not always support higher ratings.

Larger REITs often have lower overhead burdens and unsecured borrowing costs. However, these savings do not always translate into stronger credit metrics for bondholders.

Fitch views access to capital as more important to REIT credits than cost of capital from a default probability perspective. Indeed, refinance risk, rather than interest payment default, is the principal risk to REIT credits given generally longer term leases to credit tenants against the backdrop of strict financial covenants in most REIT bond indentures.

Size could actually begin to work against larger REITs if they have a large amount of unsecured maturities that will need to be refinanced annually.   It is unclear whether the depth of the market would sustain in periods of stress and obtaining mortgages to satisfy these large maturities could be a long and arduous process. It can also add complexity to and dilute the quality of bank syndicates.

There is no empirical evidence that size and default probability for U.S. equity REITs are inversely related. That said, an interesting anomaly is GGP, which to this day is the sole equity REIT unsecured borrower to default since the modern REIT era began in the early 1990s. Despite having a total enterprise value of $40.5 billion in 2007, GGP was unable to refinance its maturing Rouse bonds when the unsecured debt capital markets froze in 2008. GGP’s secured borrowing strategy caused it to have insufficient unencumbered assets to use as a source of contingent liquidity.