While recent trends indicate slower economic expansion than we had initially forecast for 2013, Standard & Poor’s Ratings Services maintains a stable ratings outlook for the North American real estate investment trusts and real estate operating companies (collectively REITs) sector for 2013 and 2014. Our expectation for a continued gradual recovery in the economy, combined with our belief that modest growth in GDP, employment, and consumer spending will drive continued occupancy and rent improvements, support this outlook.
Steady occupancy and rental rate gains underlie our expectation for most REIT ratings to remain stable. We think that any rating momentum would likely have a positive bias, resulting from individual company performance or events, because roughly 13% of REIT ratings currently have positive outlooks (or are on CreditWatch with positive implications). New supply remains largely consistent with recovered demand. REITs continue to have good access to capital markets, despite the rise in interest rates, and debt and preferred issuance has amounted to roughly $14 billion year to date.
When we form our base-case outlook for the North American REIT sector, we focus mainly on the economic indicators that most correlate with tenant and investor demand for real estate, as well as factors related to new supply. Although we also monitor several other economic indicators, we believe U.S. real GDP growth, inflation, real commercial construction, and consumer trends are the most meaningful. We expect the U.S. economy to grow modestly through 2014. Additionally, despite the effects of the U.S. federal budget sequestration and higher income taxes, we expect key economic indicators that affect REITs to continue to support our stable outlook on the sector.
Our base-case outlook assumes the following expectations:
- U.S. real GDP growth of just 1.7% in 2013, improving to 2.9% in 2014;
- Consumer Price Index growth of 1.5% in 2013 and 2014;
- Unemployment of 7.5% in 2013 and 7.1% in 2014;
- Real commercial construction decreasing 0.9% in 2013 and then growing 4.7% in 2014;
- The consumer sentiment index improving to 81.7 in 2013 and 85.9 in 2014;
- Consumer spending growing 2.1% in 2013 and 2.8% in 2014; and Retail and food service sales rising 4.6% in 2013 and 3.8% in 2014.
Despite the recent rise in interest rates, and the concurrent pullback in REIT stock prices, we believe that real estate market capitalization rates will remain steady (particularly for better quality assets) providing some support for stability in property values.
We expect improved cash flow generation (from rent growth and slowing occupancy gains) and continued (but tapering) attractive refinancing opportunities to offset the dilutive effect of asset recycling and resumed development activity. We believe the housing recovery under way has benefited certain REITs focused on retail/distribution and some office segments. Thus far, it appears rental household growth is keeping pace with new apartment supply in most markets (with Washington, D.C. being the most notable exception).