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Uncertainty Around Interest Rates Takes its Toll on REITs

Stubbornly persistent inflation has altered the outlook for interest rate cuts and publicly-traded REITs paid the price in April as a result.

The U.S. inflation rate rose moderately in March with the personal consumption expenditures price index and the core PCE price index each up 0.3%. Annual inflation remains near closer to 3% than the Fed’s 2% target. Those numbers, along with near-record-low unemployment, have dimmed expectations for when the Fed may cut rates. Early in the year, markets expected up to three rate cuts before the end of 2025 starting as early as March. Now some believe the Fed won’t touch its target until September.

The shifting outlook took its toll on publicly-traded REITs, with the FTSE Nareit All Equity Index seeing total returns fall 7.91% in April. That pushed the year-to-date number to -9.11% as of the end of April.

Nearly every property sector experienced some declines. Apartment REITs (up 2.26%) and healthcare REITs (up 0.86%) were the lone exceptions, eking out rises in total returns. Meanwhile, year-to-date specialty REITs—a bit of a catch-all category for extremely niche property sectors—are up 7.43% and joined by apartment REITs (up 2.72%) and single-family rental REITs (up 0.79%) as the only segments in positive territory.

On the negative side, industrial REITs had the worst month (down 18.87%) and have fared the worst year-to-date (down 20.90%). spoke with John Worth, Nareit executive vice president for research and investor outreach.

This interview has been edited for style, length and clarity. Can you put the monthly and year-to-date numbers into context? Was this a case of broader economic factors driving down the numbers?

John Worth: It’s a continuation of a theme that we’ve seen over the last 18 months where REITs are macro-driven in the sense that they get moved around more by interest rates than by their individual or collective operating performances.

In April, we saw the 10-year rise from 4.3% to a peak of 4.7% before ticking down a bit. That drove down REIT valuations. The all-equity index was down 7.9% for the month, taking it down to -9.1% on a year-to-date basis.

So far in May, there’s been some rate moderation and a bit of a REIT recovery. The index is up around 3% so far in March, and the year-to-date figure has improved to -6% as the 10-year has retreated to the high 4.4s.

What gives us some comfort about this is that we know REITs are prepared for a period of high interest rates. Their balance sheets are sound. They’ve termed out their debt, reduced the amount of debt on balance sheets and capital markets are open for REITs. They’ve been able to issue equity and debt. They are well suited to perform through this period.

Overall operational performance has been good. And when we get to interest rate policy normalization, historically, we have seen those as periods in which REITs not only rebound but outperform.

WM: You laid out how the macro environment has affected total returns, and it’s pretty much across the board. But is there anything that sticks out when drilling down into different property sectors?

JW: There are some concerns about the industrial/logistics sector and slowing demand growth and how quickly it will recover. That may drive some sector performance. Industrial is the worst sector on a year-to-date basis

WM: I noticed data centers and telecommunications also took a hit. We’ve talked in the past about how some of these “new economy” sectors have performed well and been popular among investors. What’s happening with these segments?

JW: We’ve seen telecommunications underperform the index last year and into this year. Fundamentally a lot of what’s going on there are concerns about the speed of demand growth for telecom towers. The sense from earnings season is that there is going to be some renewed demand coming up later this year and into next year.

For data centers, which were the best-performing sector last year, it’s a bit of a retrenchment after a really strong run.

WM: You mentioned that REITs have still been able to raise debt and equity when they have wanted to. What have they done so far in 2024?

JW: In Q1, REITs raised $17.9 billion from secondary debt and equity offerings, with debt issuance accounting for about $13 billion of that. Most of the rest of that overall figure came from common equity issuances. What that doesn’t capture is “at market” issuances. We capture that figure on a lag. So total issuance was probably a tad higher.

The Q1 figure was substantially higher than Q4 of 2023 and a bit higher than Q1 2023. At the beginning of the year REITs viewed it as a good time to go to market. There was a lot of issuance with interest rates and corporate spreads compressed.

In this period, when the rate environment was attractive, we did see REITs issuing debt and taking care of some refinancing. Because of the structure of REIT balance sheets, they have been able to pick and choose when to go to the market. They haven’t been forced to raise debt. They are able to find these opportune times to come in. It was really frontloaded so far this year and once we saw rates tick back up, issuance slowed again.

WM: We’re also getting close to the next T-Tracker summarizing quarterly results. What are you seeing from what’s been reported thus far?

JW: Our sense is that this is going to be a good quarter. We are seeing a continuation of the fourth quarter of 2023 with REITs posting solid operating performance on a YOY basis. In the context of a slowing economy and a somewhat slowing commercial real estate market, REITs are continuing to put on year-over-year rent growth and NOI growth at or above the rate of inflation and paying out meaningful dividends that are growing over time. They’ve been able to maintain their levels of occupancy.

We did a market commentary recently comparing the occupancy rates you see for REITs and what you see in ODCE funds. It highlights that across the property sectors, REITs have higher occupancy rates, signaling the relative quality of their real estate.

With balance sheets, we’ve also seen more of the same recent trends in terms of the strength of balance sheets. There remain low leverage ratios, long weighted-average terms to maturity and a weighted average interest rate that’s under control and reflecting the high percentage of REIT debt that is fixed rate and unsecured.

This report is going to be consistent with our view that REITs have balance sheet capacity to work through higher rates, but that they are also putting up solid operational performance.

WM: With the last T-Tracker, there was also the narrative that while there is still growth in many of the fundamental metrics, the pace of growth has decelerated. Are you seeing any further deceleration this quarter?

JW: We are not yet at the end of the process, so it’s hard to say whether year-over-year FFO and same-store NOI growth rates are higher or lower. Right now they look quite comparable and I’m not sure we will see continuing tapering this quarter.

WM: I understand you also have a new study coming out assessing actively-managed portfolios. Can you talk about that?

JW: This is a study by CEM Benchmarking, which I know we’ve talked about to you before. It’s a little different and an extension and expansion of the CEM studies that you’ve seen before, which have asked, on average, what are the returns of different asset classes. What we have highlighted before is that when you look at the 24 years of data, you see REITs outperform private real estate on average 2 percentage points per year.

The new study asks a slightly different question. It’s looking at what are the returns or value-added for active management for REITs and private real estate and how those differ across distribution channels.

On a gross-of-fee basis, before accounting for expenses, both REIT and private real estate create value compared to benchmarks. For REITs it’s by 84 basis points and private real estate by 101 basis points. However, net of fees, you see a difference. REITs outperform by 32 basis points, while private real estate underperforms by 68 basis points. The fee drag in the private real estate space impacts that net performance that investors ultimately receive.

One of the other things that’s different is that we can look across that distribution of returns. And between the 10th percentile and 90th percentile and even slightly above, we see REITs outperform at all those percentiles.

It gets to what’s often a question discussed by real estate investors in how to think about top-quartile managers. A frequent discussion when looking at public vs. private is that plan sponsors will say, “We understand private real estate underperforms on average, but we only use top quartile managers.”

What we found here is that even among the top quartile and decile managers, REIT active management outperforms private real estate. If you are able to identify those top quartile/decile managers in the REIT space, it will provide higher returns than the top managers in the private real estate space.

We think the audience for this is mostly in the institutional space, where we think it’s an important component of why institutions should be using REITs and private real estate together, to use all the tools.

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