A drop of 4.97 percent in total returns in December dragged the FTSE All Equity REIT to -24.95 percent for 2022. That meant publicly-traded REITs had their worst year since 2008, amid the Great Financial Crisis, when total returns fell nearly 40 percent.
There have also been questions raised in the market after several non-traded REITs put limits on redemptions, which has created some confusion for the publicly-traded side despite the different ways the two segments function in terms of pricing.
In fact, many real estate fund managers, including Cohen & Steers and Hazelwood Investments, are bullish on REITs for the year. They believe a recession has already been priced into REIT stocks and that REIT balance sheets are well-positioned to weather any economic storms.
That matches the outlook published by Nareit, the industry association for the REIT sector in the U.S.
WMRE spoke with John Worth, Nareit executive vice president for research and investor outreach, to discuss the outlook for REITs in 2023.
This interview has been edited for style, length and clarity.
WMRE: Talk a bit first about the 2023 outlook you put together and some of the key takeaways from that.
John Worth: The word of the year in 2022 was “divergence.” There was a substantial divergence between stock market returns for REITs vs. earnings as well as a strong divergence between public real estate and private real estate.
In 2023, we think the word is going to be “resilience.” In the face of an uncertain economy and rising rates, REITs are well prepared. They have built balance sheets that can weather higher rates. The profile includes low leverage ratios, well-structured debt with more than 80 percent in fixed rate and average term to maturity of over seven years. As we’re looking ahead, this is not an economy or interest rate environment that are necessarily good for any sector, let alone real estate, but we think REITs are poised to successfully navigate through higher rates and slower growth.
WMRE: On that private/public question, you’ve talked about before the lag between public and private due to how they are structured. And I’ve seen a number of fund managers call out REITs as being a good bet in 2023. Can you take more about this?
John Worth: When you have large, sharp changes in the economic outlook-which I think Fed policy has been—it can take 12 to 18 months for that timing gap to close between public and private. That’s one of the reasons why we’ve traditionally seen REITs, when compared with private real estate, tend to underperform coming into recessions, but outperform during and coming out of recessions. Part of that is structure and part is the timing difference and whether valuations are forward-looking, as with REITs, or are backward-looking, like how private real estate gets valued.
The view of portfolio managers is reflective of the historical experience coming into and during recessions and how REITs have performed relative to net asset values (NAVs). When trading at meaningful differences to NAVs, you tend to see REITs perform well on a relative and absolute basis for the coming three to five years.
In terms of our broad outlook, there’s a lot about public/private divergence, but also how those markets come back together. REIT cap rates have adjusted dramatically. We haven’t seen that on the private side yet. We expect markets to come back together in 2023.
WMRE: Is there anything of significance when looking at the outlook by property type?
John Worth: The outlook looks at the broader space. One of things we’ve found is that it can be challenging to identify the specific drivers between property types during recessions. There’s a desire to say “in a recession, this property type is going to do this or that.” But in reality you need to see the specifics of each economic cycle to see how different segments are going to perform.
For example, looking over the entirety of the COVID period, the best performing sector—self storage with almost 43 percent total returns—was not the property sector that anyone would have guessed at the beginning of that period. For different property sectors it depends on the nature of the cycle and the specifics of the sector.
WMRE: Another piece in your outlook touches on something we’ve talked about a few times—the idea of institutional investors using REITs for “portfolio completion” in getting exposure to property types that might be underweighted in their overall holdings.
John Worth: In 2022 I had the opportunity to speak to many of the world’s largest real estate investors. The outlook synthesizes what we heard about how they use REITs for strategic real estate allocation. This idea of “portfolio completion” is about property types. It’s an important component of what REITs can do because they’ve been on the forefront of innovation in real estate and emerging CRE property types. It can also be about geography. REITs offer access to global real estate and markets where you may not have on the ground expertise.
There’s also an increasing understanding that you can use REITs to complete portfolios in term of ESG objectives. Investing in REITs provide access to some companies that are best-in-class in ESG performance. So fi they have ESG or risk management objectives, REITs can help them meet those objectives.
WMRE: Any final thoughts on 2022 performance?
John Worth: It was clearly a tough year for REITs. The FTSE index ended down 24.95 percent. It’s the worst annual performance since 2008, when the index was down more than 37 percent. We think, as we discussed, it was impacted by investors pricing in and looking forward to slower growth and a high rate environment. REITs are the first movers to price those things in.
Across property sectors, specialty REITs were down less than 1.0 percent for the year, powered by gaming/leisure REITs. Retail was down just over 13 percent, making it the second best performing segment. Retail showed some of that resilience on relative basis and a bounceback from difficult conditions in 2021. Lodging was down just over 15 percent, also showing some bounceback from the difficult conditions of last two years.
On the other end, industrial was down over 28 percent in 2022. But it’s a sector where we think there are clearly long-term tailwinds. And the worst performing sector, reflecting continued uncertainty, was the office segment. Even when you look over the performance over the entire COVID period, office continues to be worst performing sector. There remains uncertainty over demand conditions, which we think is a multi-year discussion as we see different organizations figure out how their employees work.