Assessments made by credit rating agencies on the creditworthiness of debt issuers are a useful measure of market views on risk. While investors may tend to associate real estate with secured debt, REITs have significant amounts of unsecured debt. Nearly 71% of REIT debt is unsecured versus secured, according to second quarter results from the Nareit T-Tracker®.
Credit rating agencies issue two types of statements about all major investment sectors, including REITs: negative (or positive) credit watches and outlooks, which warn that deteriorating (improving) conditions may lead to a downgrade (upgrade) in the future, and actual downgrades (upgrades) if those risks have been realized.
Since the beginning of the pandemic, S&P Global has issued negative credit watches or outlooks and downgrades that far outpace positive assessments for most sectors in the S&P 1500. While more than 15% of REITs (by market capitalization) in the S&P 1500 received negative credit watches and outlooks, actual downgrades did not materialize for most REITs. REITs outperformed most other GICs sectors with only 5.8% of the REIT market cap downgraded. REITs were the third best performing GICS sector by this measure.
In comparison to other sectors, REITs in the S&P 1500 have an average share of issuers with investment grade ratings by equity market capitalization as show in Chart 1. The share of REIT issuers with investment grade ratings is 83%. The sector with the highest share is Utilities at 96% and the sector with the lowest share is Communications at 67%. REITs have another almost 9% of market cap as issuers with credit ratings below investment grade.
Credit analysts assesments on the creditworthiness of issuers of unsecured debt are one measure of the effects of the pandemic. Chart 2 shows the credit watches and outlooks issued by S&P Global Ratings from January 1 to September 15, 2020 by market cap of rated issuers. Watches and outlooks were sharply negative for most sectors, averaging 13.7% of market cap placed in negative status for the S&P 1500. REIT issuers fared below average with 15.3% of market cap with a negative status. The watches/outlooks were spread across REIT property sectors affected by shutdowns or social distancing including Retail, Lodging/Resorts, and Office.
However, despite initial concerns about creditworthiness, most REITs ultimately were not downgraded. Chart 3 shows 2020 year-to-date upgrades and downgrades for the S&P 1500 by market cap of rated issuers. REITs outperformed the industry average of 10.5% of market cap downgraded with only 5.8% of market cap downgraded. Seven REITs were downgraded in this time period, across different property sectors. All downgrades preserved the investment grade status of the issuers; no REITs passed from investment grade to non-investment grade.
Taken together, Chart 2 and Chart 3 show where the pandemic created uncertainty with credit watches and outlooks high for REITs. However, experience shows, and the credit ratings change confirm, that REITs were actually not as risky as initially perceived. Nareit's rent surveys show rent collections recovered well from the initial shock of closures and pandemic macroeconomic effects. REIT balance sheets were strong heading into the pandemic with easy access to cash and lines of credit, and operating performance proved to be resilient.