By Allen Kenney

1. What is your firm's current ratings outlook for the REIT industry?

Moody's rating outlook for U.S. REITs and REOCs remains stable, even though Moody's expects modest deterioration in commercial property fundamentals after a handful of strong years. First, new supply remains moderate for most property sub-sectors. Second, many REITs took advantage of favorable market conditions over the past few years to improve the quality of their property portfolios and to shore up their balance sheets with lower leverage and enhanced financial flexibility. Overall, Moody's believes REITs are well-positioned for the current market cycle.

That said, Moody's remains cautious about liquidity and is closely monitoring those firms with large development pipelines, upcoming debt maturities and other sizable funding needs over the intermediate term. Given their dividend requirements, REITs retain little earnings. Consequently, they must access external sources of capital to meet their financial obligations and to fund growth. During the positive financing environment of recent years, this basic truth sometimes was forgotten. Consequently, Moody's believes investment grade REITs with access to multiple sources of capital, both private and public, are best positioned to withstand the current capital markets turmoil. Conversely, we believe lower-rated firms, with lower-quality assets and locations, face bigger challenges ahead.

2. One of the bigger themes in the REIT market during the past few years has been the proliferation of leveraged privatizations. Is that period officially over?

The short answer is yes. Most of these privatization transactions relied on cheap financing that was often short term and secured and had generous underwriting assumptions. However, the widening of spreads and the lack of liquidity in both the CMBS and unsecured debt markets make it difficult to obtain cost-effective financing, or, for that matter, to even get a deal done. An example is the Archstone-Smith acquisition by Tishman Speyer and Lehman Brothers Holdings, which was re-priced and delayed.

The only exceptions that Moody's can envision are deals involving pension funds or similar long-term, well-financed investors. Moody's could also see more in-market consolidation with public-to-public transactions, driven by larger REITs with moderate leverage and good financial flexibility.

3. Given the current volatility in the global financial markets, are there any specific REIT sectors that you think are particularly well suited to hold their ground—or even thrive—in the coming months?

Our ratings outlook for each of the major property sub-types remains stable. That being said, Moody's does think that industrial REITs have the potential to generate more stable earnings over the coming year. Industrial REITs are entering this real estate cycle with high occupancy levels for their portfolios. The manufacturing economy has been slowing: the latest Purchasing Managers Index (PMI) reading in March 2008 was below 50 percent at 48.6, but it was higher by .3 percentage points than it was in February. A PMI reading below 50 percent indicates that the manufacturing economy is contracting. Manufacturing output is a key leading indicator of absorption in the industrial property markets. However, the industrial REITs' high portfolio occupancy and tenant retention rates should help mitigate the effects of the current PMI reading.

Moody's also expects health care REITs to fare relatively well. The health care sector is not as exposed to economic cycles. Rather, it's driven by factors such as demographic trends, spending patterns and government reimbursement levels. Demographic trends and spending remain positive, and Moody's does not expect any significant changes in government reimbursement, at least for the intermediate term, because this is an election year. Furthermore, Moody's expects that health care REITs with financial and operational wherewithal should be able to take advantage of rising cap rates and seize investment opportunities. Increased investment activity could help health care REITs achieve not only higher earnings, but also increased size, leadership and diversification.

4. What lessons should listed public real estate companies learn from this recent downturn in REIT share prices? What are the most daunting challenges and intriguing opportunities ahead?

Capital had become so plentiful in recent years that some companies began to take it for granted. Most anyone could rapidly obtain cheap debt with generous underwriting terms, and many became overconfident that this wave of liquidity would continue indefinitely. As many have learned in the single-family mortgage space, liquidity can vanish instantly. The consequences can be harsh—just look at what unfolded in the mortgage REIT industry.

Moody's thinks that REITs with high amounts of short-term debt, riskier asset portfolios, heavy reliance on secured debt or narrow business models will be the most challenged in the months ahead. On the other hand, those with size, quality management, modest leverage and significant financial flexibility will be poised to take advantage of pressures on commercial property prices.