Elevated Equity REIT Bank Borrowing Bears Close Watch

By Steven Marks, Head of US REITs, Fitch Ratings

Much has been made in the equity REIT sector about the strength of the unsecured debt market since 2010, and the sector’s ability to access it with relative ease and frequency. One element equity REITs have been unsuccessful in capitalizing on, however, is the strength of the unsecured bond market to reduce bank borrowings. Consequently, bank borrowing is now at highs not seen in a decade, with liquidity and funding risk on the rise as well.

U.S. equity REITs have seen a significant rise in commercial bank borrowing. As of March 31, 2017, bank borrowing exposure among equity REITs accounted for 17.5 percent of total debt. This represents a sizeable increase from 8.5 percent at the end of 2010. While not a new phenomenon, exposure could constrain corporate credit quality for some REITs if bank borrowing continues at this elevated level.

Access to multiple forms of capital is a characteristic of investment-grade REITs. As such, weakening in the unsecured bond markets would challenge REITs to tap additional unsecured bank borrowing, something that Fitch Ratings has historically viewed as a credit negative. Companies that already have fewer sources of funding could be susceptible to rating downgrades and/or negative outlook revisions if they are unable to obtain cost-effective unsecured funding via the bond or bank market.

Available options

It’s not that REITs are devoid of options in accessing long-term unsecured debt funding. The unsecured REIT bond market has grown in each of the last five years. In addition, the private placement bond market has been a secondary option for smaller issuers and for select previously public-only issuers seeking lower-cost financing. This market strength has not been unique to the REIT sector—corporate bond issuance has been robust as well due to shrinking risk premiums, as the market has sought yield in a low interest rate environment.

Though REITs are tapping term loans more frequently, the sector remains prudent in maintaining good availability under unsecured revolving credit facilities. The March 31, 2017, average and median drawn levels were 20.9 percent and 11.1 percent, respectively, slightly lower than in recent periods. These facilities represent REITs’ largest source of immediate liquidity given the relatively limited cash retention abilities due to REIT dividend distribution requirements.

Nonetheless, continued bank borrowing at this elevated level is a valid concern and one that needs to be watched closely in the coming quarters for equity REITs.