Listed property companies in the US significantly improved their liquidity profiles during the second quarter, in anticipation of an eventual downturn, according to Fitch Ratings.
The median liquidity coverage ratio for select US equity real estate investment trusts (REITs) in each major property group increased by 20% or more from the prior year to stand at 1.7 time earnings, its analysis found.
“REITs are adopting a lessons-learned approach by bolstering cash reserves, reducing revolving line-of-credit balances and consciously spacing out debt maturity schedules to prevent any near-term shocks,” said Fitch managing director Steven Marks.
REITs are now “better prepared for less favourable conditions as median cash balances more than tripled” in the year June 30, 2016, while average line of credit balances were reduced by 31.9%.
Fitch says REITs also reduced debt by refinancing, extending and prepaying obligations – adjustments that reduced debt maturing between now and 2018 by nearly $900m.
In the face of weak stock prices and a volatile bond market early in the year, REITs relied heavily on unsecured term loans for financing in the first quarter, and issuance of traditional debt and equity securities dropped more than 25% from the first quarter of 2015.
As equity values recovered and global demand for positive-yielding debt remained high, debt costs “declined significantly and valuations recovered in recent months”, Fitch said.
As REITs returned to their primary sources of capital during the second quarter, unsecured bonds and common equity issuance by REITs accounted for $25.5bn, or 84.7% of total issuance, since 1 April.
Even as REITs bolstered their cash positions against adversity, yield spreads indicate that US listed property shares could post total returns of as much as 15% from current levels. The REIT index increased 11% by the end of August, reducing the earnings yield on REITs.
However, the spread between REIT earnings yields and REIT corporate bond yields actually widened by 75bps during the same period, according to Goldman Sachs, due to a more pronounced decline in bond yields.
As a result, REIT earnings yields are 237bps over REIT corporate bond yields, 211bps above the average spread since 2012. Were REITs to return to historical bond yield spreads, Goldman Sachs said, the sector would have a 5.3% arbitrage.
Assuming 6.5% earnings growth and a 3.2% dividend yield, Goldman estimates that total returns for 2016 will be 15% from current levels, indicating “room for upside under present conditions, despite strong recent stock performance”.
