Business & Investment

Impact of high inflation on REITs

Stephen Boyd

Inflation news was ubiquitous, especially after the Ministry of Labor announced earlier this month that the United States had experienced the largest price surge in more than 30 years during October. No one knows how long high inflation will last, but the latest estimates from the Federal Reserve can allow prices and interest rates to stabilize until 2022.

The question of the impact of inflation on REITs depends largely on the length of time it takes for interest rates to rise steadily and how high they will be. If inflation and high interest rates are temporary issues, the credit profile of US equity REITs is unlikely to be significantly affected and disruption is minimized.

However, long-term inflation and rapid rises in interest rates can adversely affect cash flow, lower asset values ​​and increase cap rates, making the refinancing environment more difficult. If the debt ratio is based on asset value, this may also emphasize the cushion of contract compliance.

During periods of extreme inflation in the past, the REIT sector was small, less diversified, and consisted primarily of mortgage REITs rather than real estate owners. As a result, its resistance has not been tested in the soaring interest rate environment we are currently experiencing. The impact of increased interest expense can vary depending on the type of property, including capital structure, portfolio lease term, and other considerations that determine the impact on the credit of individual issuers.

The financial performance in this high interest rate environment is underpinned by conservative debt levels and moderate exposure to short-term and floating rate debt. Longer weighted average debt maturities also support performance, but imbalanced debt maturity ladders can lead to refinancing shocks in certain years.

From a liability perspective, it is most often seen in the context of portfolio lease terms. Long-term leases do not provide an immediate opportunity to raise rent to offset rising costs. Conversely, REITs that own short-term, investment-intensive real estate types can quickly mark leases to the market and manage potential interest rate spikes.

If inflation is a short-term issue, REITs may maintain a solid foundation. However, as interest rates continue to rise towards the end of the year, it is important to monitor the trajectory of inflation and its potential impact on REITs after 2022.

Stephen Boyd is a Senior Director of Real Estate and Leisure in the United States. Fitch Ratings..

Impact of high inflation on REITs

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