Fair Value Accounting for Investment Properties Is on the Horizon: How Will it Affect REIT Bond Covenants?

Abstract

Key Take-Aways - Fair value accounting for investment property is on the horizon, possibly as early as 2008, although the details remain unclear. - A fair value accounting regime could change how the total assets component of REIT bond covenants is defined. The most common definition is currently undepreciated cost. Definitions with fair value aspects could become more common. However, we do not believe pure fair value will become the new standard definition of total assets in covenants over the short term. - A change to fair value accounting could accelerate the diversification of REIT covenant definitions that is already underway. Over the long term, it is possible - with more acceptance of fair value accounting - that pure fair value will become the new standard definition of total assets in REIT covenants. - Covenant changes made to date do not particularly concern Moody's as we have not seen a change in REITs' overall appetite towards leverage and secured leverage. Should REITs start using the flexibility of less restrictive covenants and/or issue senior debt without key covenants (such as minimum levels of unencumbered assets and secured debt limits) to lever up and increase secured debt levels, reducing their unencumbered property portfolios, Moody's would expect negative rating pressure.