In the face of the broader uncertainty hanging over the commercial real estate investment market, publicly-traded REITs have maintained healthy balance sheets and continue to report strong revenues.
The latest Nareit T-Tracker report, compiled based on the latest quarterly earnings results of publicly-traded REITs, found that funds from operations (FFO) reached $20.6 billion, up 4.2% year-over-year compared with the second quarter of 2022. Meanwhile, 79% of REITs reported using unsecured debt and 91% of total debt was locked in at fixed rates.
Despite the solid numbers, the Nareit All Equity REIT Index was down 3.33% in August, although those numbers are in line with the broader stock market results for the month.
WMRE spoke with Edward F. Pierzak, Nareit senior vice president of research, about the latest T-Tracker numbers, some recent Nareit research and the August results.
This interview has been edited for style, length and clarity.
WMRE: Let’s start with the T-Tracker numbers. What are some of the takeaways there?
Ed Pierzak: We feel really good, number one, on REIT balance sheets. They continue to be in great shape. Leverage ratios are still below 35%. And the weighted average term to maturity is nearly seven years. It really affords REITs the luxury that they don’t have to get exposure to some of the issues and turmoil in the mortgage market. REITs’ cost of debt now is about 4.0%. Although we have seen that number creeping up, it is a low number overall, particularly when you look at Treasuries in Q2 and today.
There are two other measures to look at. One is percent of fixed rate debt as percentage of total debt. That’s at 91.4%. So, REITs have been avoiding variable rate debt. Lots of folks today if they have debt due, wish they had that.
And lastly, 79% of REIT debt is unsecured debt. That is a competitive advantage. When there are challenges in the mortgage market, REITs have access to significant amounts of capital and it typically comes at a really good price. Looking at the deals from the first half of 2023, there was a median value of 5.1%. That’s really attractive when you stack that up with secured debt or mortgages.
WMRE: How about on the operational front? What did the second quarter numbers show?
Ed Pierzak: Operations have been holding up pretty well. On a quarter-over-quarter basis, we are starting to see some weakening. That is not that surprising. On a year-over-year basis, the numbers still look good, with FFO up 4.2%. Same-store NOI is at 5% year-over-year. Even though these levels are a bit lower than the last few quarters, they are still keeping pace with inflation. One of the other important elements is occupancy rates: the average occupancy rate is 93.4% The numbers are good.
WMRE: You referenced inflation. I wonder, do you also monitor expenses in T-Tracker or is there some way to capture how REITs might be dealing with rising costs?
Ed Pierzak: One way to look at it is FFO. More broadly, for real estate, NOI is a great measure. The math of that is to take gross income and … subtract out expenses. And then you get down to NOI. So NOI is accounting for expenses.
WMRE: Were there any notable differences in performance by property type?
Ed Pierzak: With same-store NOI, for the most part we see solid gains across the board. With industrial we had the largest year-over-year gain at 9.5%. Other strong performers were healthcare REITs at 8.1%. Among the weakest were office and retail. Retail tapered off a bit, with effectively a 2% gain. Likewise with office, despite the challenges that people have talked about, same-store NOI was still up 2.3%. So really, across the board, we saw positive gains on same-store NOI when we had data for it.
WMRE: So even the much maligned office sector was positive?
Ed Pierzak: That’s something we try and stress. When you dig into operations, employers are paying rent even if people are not coming in five days a week and there is still a difference across the quality of office out there. Highly-amenitized, newer buildings are doing well. REITs own a lot of those buildings.
WMRE: Moving off of T-Tracker, you also recently published a piece grappling with what’s been going on with the spread between REIT implied cap rates and the appraisal cap rate for private real estate. What were you attempting to explore with that?
Ed Pierzak: We borrowed this term “the ostrich effect.” It effectively is saying that investors, when they don’t like uncertainty or want to avoid a risky situation, pretend it doesn’t exist. We thought about this and looked at cap rates overall and that kind of aptly describes what we are seeing in the appraisal cap rates.
On the one hand, REIT implied cap rates have been hovering at 6% for the last four quarters. Transaction cap rates are closing the gap with REIT implied cap rates. But when we look at the appraisal cap rates, they’ve taken a modest and measured approach to doing their adjustments. From the third quarter of 2022 to now, they’ve only increased it about 20% per quarter. The spread to implied REIT cap rates to appraisal cap rates is 185 basis points. It’s just massive.
Private markets are acknowledging the problem, but they are not recognizing the severity of the situation. We have concluded that it is equivalent to burying their heads in the sand with one eye out to capture what’s going on.
WMRE: This gap is something we’ve talked about a few times in our conversations. Is there something that could lead the appraisal cap rate to adjust more rapidly?
Ed Pierzak: For private real estate, they may think time is on their side. But these kinds of modest and measured cap rates come with real costs. They impede the price discovery process in terms of the overall real estate market moving again. They limit transaction activity. And then, most interestingly, at the end of the day, investors are paying artificially high investment management fees because they are paying on a higher value than what is the reality.
We still have some time ahead of us. I wouldn’t be surprised if it was another year before we get some meaningful improvement.
WMRE: Lastly, can you talk about the August numbers on total returns?
Ed Pierzak: The good news is the all-equity and equity indexes year-to-date have remained positive. On the other hand, August was a challenging month. Across the major sector headings, total returns for the month were negative across the board, with the exception of industrial and data centers. But broader stock market indexes were down from 1.5% to over 5% on the month. I don’t think the performance for the REIT indexes were a REIT phenomenon. It was a broader equity market phenomenon.