Stymied by an economy plagued with a high rate of inflation and rising interest rates, publicly-traded REITs have been battered for much of 2022, with the FTSE All Equity REIT Index down more than 30 percent at one point this year. But the news has been better of late. November marked the second straight month of gains, with the total returns for the index up 5.77 percent. As a result, REITs have clawed back some losses and the index is now down 20.27 percent.
For the month, nearly ever property sector posted gains with data centers leading the way (up 18.83 percent). Healthcare REITs also posted a double-digit gain and total returns were up 11.05 percent for the month.
Strong third quarter earnings helped drive the overall results. For the quarter, REITs posted FFO of $19.89 billion, up from $19.73 billion in the second quarter and $17.31 billion in the third quarter of 2021. Through the first three quarters of 2022 REIT FFO has come in at $57.42 billion, putting the sector on track to surpass 2021 annual FFO of $64.83 billion.
WMRE spoke with John Worth, Nareit executive vice president for research and investor outreach, and Ed Pierzak, senior vice president of research, to discuss the latest monthly results.
This interview has been edited for style, length and clarity.
WMRE: Glancing at the numbers, it looks like it was a strong month across the board with a couple of sectors hitting double-digit gains. Can you walk us through the results?
John Worth: It’s the second consecutive positive month and REITs are up 9.6 percent in the two months combined. We saw strong performance across the board, with 10 of the 12 property sectors up for the month. It’s also the first two consecutive months this year where we saw positive returns for REITs.
That strong performance reflects a view about the trajectory of the monetary policy regime and the pace of tightening, but also reflects the strong earnings season REITs had. The quarterly FFO figure of $19.9 billion was the highest quarterly total ever. It’s a 15 percent increase from a year ago. Earnings on a year-to-date basis are up nearly 21 percent above the first three quarters of 2019, which came in at $47.5 billion, as well as up over last year’s figure of $48 billion. There’s been a real recovery and publicly-traded REITs are well above pre-COVID and almost 20 percent over 2021. I think the strong equity returns are in part reflective of the strong operational performance we’ve seen from REITs this year.
WMRE: Data centers were up almost 20 percent for the month. Can you talk about some of the highlights at the property level?
John Worth: With data centers in particular, coming out of their earnings season there was a sense that the supply/demand balance is quite attractive right now. And in particular on the demand side, even though we’ve seen some layoffs and some softness in the tech sector, it doesn’t look like that will impact demand for data center resources and cloud-based services. Supply conditions remain constrained and demand is going to continue at a meaningful clip.
In talking to institutional investors, one of the themes we’ve seen is using REITs and listed real estate as a way to get to “portfolio completion.” REITs can be a way of getting access to property sectors, like data centers, that may not be in institutional investor portfolios. And there are other methods, but not with the ease that they can get to them in listed space.
WMRE: With data centers in particular, it’s struck me as a tough market to crack because of the barriers to entry and how difficult of an asset class it is to manage.
John Worth: It’s a great example of a property sector where scale is important and where having a network is important. It’s a benefit to be able to offer a global network of facilities as opposed to a single property, as you might be able to do in another property type. It is also a high barrier in terms of technical expertise of the real estate you need to run. You need to have an operating platform that’s permanent and human capital and scale efficiency that’s built over years.
You can see some of those same factors across an increasing number of property types. And one of the themes we’re seeing in the current climate is that real estate as a passive investment is over. You always need to be actively managing the portfolio and the assets. And that means making investments in data science and proptech and the ability to bring scale and expertise are all critically important.
WMRE: Last month was also your REITWorld annual conference. Were there any major takeaways from the event?
John Worth: The tenor of REIT world mapped to the third quarter results. Operational performance has been good, but looking ahead we need to be cautious about the state of the economy. A higher interest rate environment is impacting decision making for REITs and commercial real estate more generally. Transactions have slowed dramatically. REIT transactions have been down significantly from the same time last year and from the first quarter.
There’s this sense that as we are in this higher rate environment, it is something REITs and non-REITs will have to navigate, but REITs are coming in with strong position, strong balance sheets, low leverage ratios, mostly fixed-rate debts, strong interest coverage and long-weighted average terms to maturity, which are still more than seven years. The general sense is we need to be cautious about being in a higher rate environment and cautious about a lower growth environment, but REITs are well prepared for those environments.
WMRE: Any other thoughts for this month?
John Worth: We published the latest version of an annual CEM Benchmarking study where we look at performance across asset classes from a broad range of defined benefited pension funds. This year it covers 23 years of data, from 1998 through 2020. It looks at performance in 12 asset classes. The key result is REITs do well on a relative basis compared with other asset classes. They have the third highest annual average returns and a low correlation with equities and a high correlation with private real estate. They also continued to show significant outperformance compared with private real estate, outperforming that sector by 2 percent per year on average.
This data allows pension fund managers to really get a sense of the performance not just based on index returns, but also on what their peers have realized. Importantly, it underscores why listed real estate can be a strong component for a defined benefit plan.
In addition, Ed put out an interesting commentary that looks at the performance of REITs coming into, during and coming out of recessions. We think it’s an interesting piece right now, since we seem to be potentially in the middle of the “coming into a recession” period and in 2023 a lot of people will be thinking about the “coming out of a recession” threshold, whether we actually have one or not.
Ed Pierzak: We compared REITs to the NCREIF fund index ODCE to make it as much of an apples-to-apples comparison as possible. REITs underperformed in the four quarters before a recession, which is perhaps not surprising since REITs tend to lead private market performance by six to 18 months.
During a recession, REITs outperform private real estate and coming out of a recession, they also outperform. So, there’s a lead/lag relationship that you can recognize at least over the last six recessions, which takes us back to the early 80s. In general, REITs have been well-positioned to take advantage of economic recoveries.