There's strength in our more resilient office market

“Compared to other property types, office REITs have elevated development risks, as pipelines have outsized funding needs, with this risk only somewhat mitigated by relatively healthy pre-leasing levels,” S&P’s New York-based primary credit analyst Ana Lai said.

“We expect office REITs to cut back development activities and reduce capital spending needs to limit cash outflows.”

However, S&P’s Australian analyst, Craig Parker, said Australia’s office market had buffers that meant it was unlikely to suffer the slowdown in development activity seen in the rest of the world.

“The REITs [in Australia] all tend to have pre-commitments underpinning their projects, and that seems to be consistent with the approach the landlords have always taken, but in other markets it is very different, they are somewhat more speculative,” Mr Parker said.

“Landlords in other markets are probably going to adopt more of an Australian approach, which has always been traditionally more prudent in seeking a sizeable pre-commit before they put a shovel into the ground.”

Mr Parker added that with such low vacancy rates in the two biggest office markets of Sydney and Melbourne, Australia had more capacity to deal with a slowdown in the economy.

“In the early ’90s we had the banks, through their finance arms, generating space on a speculative basis, which is why we had 20 per cent vacancy… but now you’ve got 5.8 and 3.4 per cent vacancy and more prudent landlords that are more accountable than perhaps the banks’ finance arms were in the early ’90s,” he said.

Negative outlook for US

S&P rated 46 office REITs globally, of which 15 per cent had a negative outlook. The highest proportion of negative outlooks was in the US at 27 per cent, followed by Europe, the Middle East and Africa with 13 per cent. In the Asia Pacific region it was just 7 per cent.

In Australia, AMP Capital Wholesale Office Fund, Dexus, GPT Wholesale Office Fund and Investa Commercial Property Fund were all rated A- with a stable outlook. Charter Hall Prime Office Fund was rated BBB and stable.

S&P said office REITs remained a largely investment-grade sector with most rating in the BBB category.

“The issuers with negative outlooks generally face heightened development risks and limited cushion on credit metrics to sustain a downturn,” the report said.

Mr Parker said Australian REITs tended to be rated higher than elsewhere not because of better office buildings but because those landlords being rated adopted a more conservative financial stance.

“In deeper capital markets [like the United States] you have a deeper pool of landlords that want to get rated so they can then access capital debt markets,” he said.

S&P expects most European office leasing markets to falter in 2020 and 2021 due to the weakening of long-term fundamentals.

“Consequently, our rated office landlords’ major markets, such as Paris, Madrid, Berlin, Frankfurt and Warsaw, should experience a slowdown in leasing activity in 2020,” the report says.

“Following years of positive revaluations, they may reverse to negative 5 per cent in 2020.”