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Breaking Down September’s Double-digit Drop for REIT Total Returns

The Fed’s continued aggressiveness in raising interest rates and growing fears of a recession took a toll on publicly-traded real estate equities.

Publicly-traded REITs saw total returns fall 12.72 percent in September, leaving the FTSE Nareit All Equity REITs index down 27.93 percent year-to-date. REITs have been swept up in the broader decline for equities, including the Nasdaq Composite (down 32.00 percent year-to-date through Sept. 30), the S&P 500 (-23.87 percent), The Russell 2000 (-25.10 percent) and the Dow Jones Industrial Average (-19.72 percent)

The Fed’s continued aggressive moves on interest rates and prospects of a recession have taken their toll. The slowdown in residential real estate with single-family housing values dropping, mortgage rates rising and sales volume slowing may also be shaping perceptions of the commercial real estate market.

Looking ahead, REITs will begin reporting third quarter earnings later in October, which could provide some clarity on whether effects of weakness in the broader economy are showing up in REIT portfolios.  

WMRE caught up with John Worth, Nareit executive vice president for research and investor outreach, to discuss the latest monthly results.

This Q&A has been edited for length, style and clarity.

WMRE: Start us with the big picture. It was another rough month for REITs with total returns down across the board.

John Worth: For REITs and equities generally, September was another tough month. The overhang of Fed monetary policy adjustments and the prospect of slower growth ahead affected REITs and non-REIT equities. There is broad concern about a rising rate environment and slower growth. That impacts REITs. That impact comes even though the current operating performance has been quite strong.

We are headed into earnings season, which starts in a couple of weeks. We will be tracking earnings very closely to see if we start seeing any signs of weakness in the macro economy show up in REIT operating performance.

We have seen a couple of REITs provide operating guidance and those have been quite strong. So, we are likely to see another strong quarter of earnings for REITs. And we also expect REITs with conservative, well-managed balance sheets to be prepared for a period of high rates.

So, in that way the story is not different than August. It’s been a tough stretch for total returns. But REITs remain positioned and have historically performed well in periods of high inflation.

WMRE: Does anything stand out at the property level? Every sector was down for the month. Most—except for residential—were down double digits.

John Worth: There were a couple of outliers. Industrial was the worst performer, followed by data centers and then timber. Those are sectors where you might have more concerns about the macroeconomic performance and the role of consumer demand as it may impact the demand for real estate. But in general, when you look across the year-to-date results, it’s consistent with that. The worst performers for the year are data centers, industrial and office.

WMRE: With offices, it feels like we’re inundated with lots of data points and anecdotes on office usage all of the time, but generally there are not any big shifts. Perhaps more of note was the recent decision by Facebook to put some of their space in New York back on the market. At times people pointed to demand from tech companies for office space as a good long-term sign for offices even if the near-term was uncertain. Does that change anything?

John Worth: My read on the Facebook decision is that it’s more driven by their head count in New York as opposed to whether they think people will be in offices or not. If you have a period of slow growth or a recession and you have head counts shrinking that is going to impact how much space is demanded in the office sector. The performance of office REITs overall is consistent with those concerns. So, I think it’s primarily concerns about the macro environment and with office there’s that second layer of concern about the ongoing impact of work-from-home, particularly as you go into slower growth environment.

WMRE: How are REITs communicating with investors in the current climate? If investors are looking at their homes or the housing market in general and seeing a slowdown and mortgage rates going up, do they then assume that it might be a bad time to invest in all real estate?

John Worth: It’s an important point. Over the years we’ve talked with investors and financial advisor communities. Most frequently, you get the question. “I own a house. It’s big part of my net worth. So I own real estate. Why would I need more real estate in my portfolio?”

So, there is an ongoing importance to be clear about the differences between residential and commercial. Residential real estate is a consumption item with some forced savings tied to it, while commercial real estate is an investment and provides a steady stream of income along with asset appreciation. The return profile of residential and commercial real estate has been very different.

We look at it in the form of REITs, but commercial real estate widely outperforms in terms of capital appreciation or if you look at total return.

The second piece of that question goes to what we’ve talked about in previous months about really understanding the scope of real estate today. Real estate is so much broader than what you experience driving around.

What individual investors often think comprises commercial real estate is “retail and office.” But, of course, those are just two pieces of a much broader picture. We have REITs focused on dynamic growth sectors like e-commerce, data centers, logistics, in addition to things like self-storage, hotels and multifamily. Those are all part of the CRE landscape.

WMRE: I assume also in the conversations you point to REIT fundamentals and how those have held up.

John Worth: It is also going back to that. Earnings have been strong. Most sectors in the REIT space have FFO that is higher than pre-COVID. Earnings have fully recovered plus some more. And they are well-prepared for a period of rising rates with low leverage, termed-out debt and holding predominantly fixed-rate debt.

Over the past month or so, we’ve done a lot of investor meetings including in Europe, California, Chicago and online. Institutional investor interest in some of the nontraditional property types has really been coming through in those conversations, those outlined in your survey. We’ve had talks about how investors can use REITs to fill in gaps to create a well-balanced portfolio that reflects the modern real estate ecosystem. It has become an important topic with institutions who have realizing that a traditional ODCE focused-portfolio is out of step with the broader shape of the economy.

WMRE: Any additional themes for this month?

John Worth: We published the annual Economic Contribution of REITs in the United States study. For 2021, REITs supported 3.2 million jobs representing $229 billion of labor income. That encompasses direct operations of REITs, the impact of the dividend/interest payments and property improvement and construction, along with the contributions of businesses supported by the spending of REIT employees, bondholders, and shareholders. Over the last five years, REIT economic contribution has grown pretty substantially. It underscores that REITs are important contributors to communities, but also points to the role of commercial real estate more generally since REITs are just part of the overall picture.  

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