According to new research from Nareit, the association representing publicly traded real estate companies, 168 million Americans, roughly 50% of all U.S. households, have some exposure to public REITs. That ownership comes in direct stock ownership or through mutual funds, ETFs or target date funds that include REITs.
Nareit generated that number by analyzing the Survey of Consumer Finances produced by the Federal Reserve. According to Nareit, “Direct holdings of stocks increased from 15.2% of households in 2019 to 21.0% in 2022. Most households’ equity investments are through tax-deferred retirement accounts that increased from 50.5% of households in 2019 to 54.3% in 2022.”
Other recent analyses from Nareit looked at the state of REIT balance sheets and provided an update on the valuation gap between private real estate and public REITs.
WealthManagement.com spoke with Edward F. Pierzak, Nareit senior vice president of research, about the reports and January’s results.
WealthManagement.com: Let’s start with the findings on U.S. household exposure to public REITs. I have been thinking about this recently, given how many mutual funds and ETFs include REITs and retirement plans. What do you make of the number?
Ed Pierzak: We have had a material increase in equities ownership. If you go to 2019, it was 15%, and in 2022 it’s up to 21%. That’s one way exposure has increased. The most significant benefit to REIT ownership is target date funds. This shows that typical Americans are getting more exposure to commercial real estate, and they are doing so through their traditional 401Ks, mutual funds, and target date funds, which have become increasingly popular.
WM: You recently wrote a piece updating the state of REIT balance sheets. We have touched on this in the past, with REITs generally sitting in a strong position in terms of rates, fixed vs. floating rates, and long maturities. Is that still holding up?
EP: If we go to a broader picture and the performance we saw in January, it’s an extension of that. January numbers were disappointing in that REIT total returns were slightly negative with a loss of not quite 5%. The Russell 1000 had a narrow gain of about 1%. The performance across sectors was consistently negative, with the exception being data centers, which were up 3.5%. That’s no surprise given all the tailwinds they’ve had amid discussions of AI. It’s a sector in which we’ve seen a lot of active REIT investment managers take overweight positions.
If we take a longer view and go from mid-October to the end of January, REITs are still up 16.2%. That’s a solid gain compared to a 14% gain for the Russell 1000.
So, you can look at all that and say, “What happened in January?” The year started with the expectations of economists and financial markets that the Fed was going to go on a series of rate cuts throughout 2024. Now, we’ve gotten some indications that the rate cuts may be delayed. Chairman Powell said effectively that he was downplaying the likelihood of a cut in March. Then we got the report of 350,000 jobs created in January, which was a surprise to the upside and better than economists had forecast.
The solid news is that the economy is performing well. But that’s created a likelihood of a delay in any policy loosening. So, the thinking is that there could be a reaction to that in the January numbers for REITs even though history tells us that a higher rate environment does not equate to bad or negative performance for real estate, which has performed well in low, mid and high interest rate environments.
That takes us to latest piece, which is to say that if we don’t see any rate cuts, there’s no problem for REITs. The weighted average cost of debt for REITs is still 4%. It’s below the current 10-year Treasury. Over 90% of REIT debt is fixed rate, and almost 80% is unsecured. That should prove to be a competitive advantage. The prospects for REITs are quite good and we think they will outperform private real estate.
WM: That’s a nice segue into your other piece, which was an update on the spread between public and private real estate valuations. We’ve talked about the concept of those converging for a while. Where are we in that process?
EP: The delta between REIT implied cap rates and private real estate cap rates are still over 200 basis points. If REIT cap rates came all the way down to private, property valuations would have to increase by 50%. That’s unlikely to happen. But we think there will be a convergence through some gains in REIT performance and some writedowns on the private side. Both sides will be active participants in the process.
WM: In just thinking about the interest rate picture, and inflation for that matter, one factor here is that many leases are written with bumps tied to inflation, correct? So, isn’t that a factor in why REITs can weather the current interest rate environment?
EP: We are about 30% into quarterly earnings reporting to our T-Tracker. We will have a fuller picture in a month, but when we look at operational performance, we find that REITs have been keeping pace with inflation with operational performance. However, the strength of the gains has been waning as inflation has been declining.
It is an intermingled story. One of the things we mention is access to capital. This is one of the positives. It presents an opportunity for REITs for opportunistic acquisitions as they may come to the surface.
WM: Is there any movement on that front? Or is the market still frozen?
EP: We are still in the price discovery process. It’s working through. In many ways, the private market participants will have to come to that realization. They will have to kick cap rates up a bit more before the transaction market returns to equilibrium.