With the possibility of changes to federal monetary policy on the horizon, REITs are generally well-positioned to withstand higher interest rates, according to a report from Fitch Ratings, Inc.
Conservative balance sheets and limited exposure to short-term and floating-rate debt are working in favor of the industry, according to Fitch. However, the true impact could depend on how the broader economy reacts to higher rates, said Stephen Boyd, an analyst with Fitch.
“Increases as a result of stronger economic growth could have positive implications for REIT credits,” Boyd said. “Conversely, a stagflation scenario of higher rates and weak economic growth would almost certainly be negative for REITs.”
Boyd said the most immediate impact of higher rates would be reflected in a decline in fixed-charge coverage by REIT sectors with higher levels of floating-rate debt, raising concerns about their ability to satisfy their financing expenses.
Floating-rate debt made up 14 percent of total debt on a weighted-average basis for equity REITs as of Sept. 30, compared with an average of 17.7 percent for the period between 2003 and 2012, Fitch reported. Hotel REITs were most exposed with floating-rate debt accounting for 23.8 percent of total debt as of the third quarter, followed by industrial REITs at 19.7 percent. Manufactured home REITs had the lowest exposure at 7.1 percent.
“Industrial and hotels had the largest exposure of variable-rate debt… but on the positive side, particularly for hotels, they have the shortest lease tenor, essentially nightly,” Boyd said. If higher interest rates occur due to inflation, hotel REITs should be able to pass those costs through to their customers, he noted.
Industrial REITs, which generally operate on three- to five-year leases, should also be able to pass higher costs through to tenants, Boyd added. Other sectors that should be able to absorb a spike in interest rates include self-storage and multifamily, according to the Fitch report.
Other factors to consider in assessing the impact of higher rates include debt schedules. REITs with staggered debt maturities are better positioned in a rising rate environment, the Fitch report stated.
“REITs generally have well-balanced maturity ladders, so we view that as a credit positive for the sector,” Boyd said.
The report highlighted additional ways in which higher rates could impact REITs. Increases are likely to drive capitalization rates higher, according to Fitch. They could also offset growth in internally generated same store net operating income (SSNOI) and hinder the ability of REITs to grow their funds from operations (FFO).