Fitch Ratings expects overall stable credit quality for U.S. REITs in 2004, according to a new report. Still, pockets of weak performance will continue to be found in the office and multifamily sectors.

"2004 will be a year of transition for the office sector as it retreats from constrained economic conditions and sees more tangible job formations," says William Travers, a director at Fitch Ratings. "However, office REITs may still see more weakness as rents roll down following lease maturity, which will pressure net operating income and interest coverage ratios."

Multifamily REITs will continue to face a challenging leasing and operating environment in 2004 due to the imbalance between supply and demand. "Multifamily REITs need several quarters of significant employment growth to see demand return, although one element that may positively help multifamily REITs is the yet-to-be tapped demand for multifamily housing, which is implied by demographic trends," says Brendan Thorpe, a director at Fitch Ratings.

While Fitch predicts a stable outlook for industrial REITs and is cautiously optimistic that demand for industrial space will be marginally positive in 2004, there are signs that news of an economic recovery may once again motivate industrial developers, which does not bode well for the industrial sector.

"Speculative development has increased and Fitch is concerned that the acceleration of new product delivery, particularly in the bulk warehouse segment where investor appetite will be strongest, will retard absorption and frustrate price increases," says Tara Innes, a managing director at Fitch Ratings.

The primary focus for retail REITs in 2004 will be underlying tenant performance as a majority of retailers are only showing moderate improvement in same-store sales activity, which leaves midlevel department stores, toy and music specialty stores and less-dominant grocery chains particularly vulnerable, according to Fitch. While Fitch expects some store closings to be announced over the next few months, they will not be enough to derail overall net operating income (NOI) or Fitch's stable outlook for retail REITs.

The rosiest picture in Fitch's REIT universe looks to be health care REITs, which have a stable outlook for 2004 and stand to benefit from favorable demographic trends that will increase demand for health care services in 2004, as well as attracting more interest from institutional investors as an attractive investment option.