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REITs End 2023 on a High Note Amid Favorable Interest Rate Outlook

When the end of a monetary tightening cycle is near, real estate investment trusts outperform. All signs indicate positive returns will continue in 2024, argues Edward F. Pierzak, senior vice president of research for the National Association of Real Estate Investment Trusts.

With the Federal Reserve signaling the end of its tightening policy and teasing potential rate cuts in 2024, the Nareit All Equity REIT Index posted total returns of 8.9% in December and finished 2023 up 11.4%. REIT fund managers are bullish on the potential for further gains in 2024 relative to the broader stock market as well as to private real estate.

The gains were broad-based during the month with self-storage REIT total returns leading the way (up 21.1%). Somewhat surprisingly, office REITs were up 19.6% as well, nudging them into positive territory for the year (2.0%).

Overall in 2023, data center REITs were the top subsegment, with total returns up 30.1% in 2023. Other top sectors for the year included regional mall REITs (tptal returns up 29.9%), lodging/resorts (up 23.9%), and single-family rental REITs (up 20.6%). The only segments to finish 2023 in negative territory were freestanding retail REITs (total returns down 1.5%), telecommunications REITs (-1.5%) and diversified REITs (-7.6%). spoke with Edward F. Pierzak, Nareit senior vice president of research, about the recent results.

This interview has been edited for style, length and clarity. It looks like REITs ended the year on a high note. Can you talk about the performance?

Ed Pierzak: REITs performed well in the last two-and-a-half months of the year. The performance pickup started in mid-to late October and continued into November and December. All equity REITs were up almost 9% for the year and almost 18% for the  quarter. When we do some of the comps to the Russell 1000 and S&P 500. REITs outperformed those by almost 4% for the quarter. Starting in mid to late October, broad market indices were up just over 12% while the all equity REIT index was up 18%.

This takes us back to the story that we’ve told you before. When we see monetary tightening policies end, historically it’s a time we’ve seen REITs outperform. Historically there is a pecking order. REITs on top, then equities and then private real estate. This is what we’ve seen when we look at these quarterly results.

WM: So where does that position us for 2024 in terms of how much runway REITs may have ahead of them?

EP: Just as we indicated in our outlook, things look very bright for REITs. We’ve had an early taste. The expectation is that it will continue into 2024. There are a few things we can look at. When we look at the spreads between REIT implied cap rates and private market cap rates, they remain quite wide. What we will see is that the implied cap rate has dropped some, but there is more gas in the tank.

In addition, when we look at operational performance, that is also solid for REITs. Lastly when we look at balance sheets, they are in great shape. The 10-year Treasury is around 4%. The cost of debt for REITs is at about 4% today. They have very attractive balance sheets. Because of that, REITs may have an opportunity to do some more acquisitions in 2024.

WM: Is that at the property level or entity level or both?

EP: Both. The transaction market on individual assets hasn’t been particularly robust. But I think as we see some price adjustments, REITs will have the ability to be selective and be acquisitive in 2024.

WM: In past conversations we’ve also talked about that spread between private real estate indices and REIT implied cap rates. Do we have a read on how much that has converged?

EP: We will have a sense when we completed the next T-Tracker in about a month. We will see some adjustments. But one thing is that up to now people have talked about how much private valuations need to decline to reflect public market pricing. In 2024, we will flip that on its head. It will be about how much REITs can increase to get to the private level. It’s a work in progress.

WM: Pivoting back to the total returns, does anything stand out at the property level for the year or the quarter?

EP: For annual results, data centers are at the top of the list. With the push with AI and other tech initiatives, there is no surprise there. When we look December numbers, self storage, office and industrial stand out Office took second place. Total returns were up 20% in December. I think that may be surprising for some folks. When we look at office, you can’t paint the entire sector with the same brush. There is very differentiated performance for different types of assets. In a recent sector spotlight, we wrote about how office will play an important role. It may be in select buildings and in select locations, but office is important.

WM: In that piece you also touched on the state of work-from-home and how we should understand the effects today. Can you talk a bit about that?

EP: Given the performance of office REITs, we thought we should look at some of the positives. With that, there are a couple of things that came up. A group of academic researchers explored the work from home concept. We looked at a survey of business uncertainty from the Atlanta Fed, Chicago Booth and Stanford. Back in August, they asked, “What is the workplace going to look like in five years?” In asking that question, they identified a modest increase in hybrid and fully remote work. But it really shows there is an importance to offices. Over 70% of respondents expected to be fully in person, 15% in hybrid and 10% fully remote. It hearkens back to this concept that offices are a meeting place, great for collaboration, creativity, innovation, knowledge transfer, and mentorship. Depending on the industry, college grads can learn a lot by being in the office.

I thought one of the other things that came up that was interesting, was when work-from-home started, there was this belief that everyone was going to be much more productive. In some ways there was truth to this. But a group of researchers started digging in. In doing a survey of arrangement and attitudes, it showed that individuals said they were equally productive in the office and only 14% said they were less productive. Researchers thought there would be a big productivity boon. There’s been an about face. If you control for commute time, productivity is that not much different. As an employee, you may view your workday including your commute time and feel like you are working 10 hours (including that commute time). But employers view it as 8 hours either way.

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