The major rebound that REITs experienced in 2021 was always going to be a tough act to follow, but a fall of nearly 8 percent for the month was not what anyone had in mind.
The FTSE Nareit All Equity REITs index rose 41.3 percent in 2021—the best single-year gain since 1976. Expectations for 2022 were that strong fundamentals and REITs on solid operating footing would enjoy more gains. And that outlook has changed. But amid a broader stock market selloff in January the All Equity index fell 7.93 percent for the month with virtually no property type exempted from the drop. (The lone exception were health care REITs that eked out a 0.19 percent gain for the month).
A few subsectors even posted double-digit percentage drops including infrastructure (down 13.89 percent), data centers (down 13.58 percent) and manufactured homes (10.37 percent).
WMRE sat down with Nareit Executive Vice President and Economist John Worth to discuss the January returns.
This interview has been edited for length, style and clarity.
WMRE: It seems like it was a rough month. Can you walk us through what these results mean?
John Worth: It was a significant selloff. Likely the real driver to most of that was the same thing driving returns in the broader stock market. We saw the S&P 500 fall more than 5 percent for the month. It’s largely a reaction to the Federal Reserve’s signaled willingness to tighten monetary policy and the impact of that.
What’s important to keep in mind when we think about REITs and interest rate changes are two broad concepts. REITs have been very resilient to changes in long-term Treasuries over the last 25 years. If you look at REIT returns over one-year periods when Treasury rates are rising you find that REITs rose in 80 to 85 percent of those periods.
The underlying point is that it’s not just the changes to monetary policy, but the context of why those changes are taking place. If monetary policy is changing and rates are rising it’s because of there’s a strong economy. That’s a context in which REITs are normally going to perform well. So, it’s important to think about how REITs perform in rising rate environments on a horizon that’s more than a single month.
WMRE: And as we’ve discussed in previous conversations, REIT balance sheets are in strong shape right now relative to other periods, right?
John Worth: Every time rates start to rise there are questions about how much leverage REITs are carrying. If you look at REITs today compared to prior to the financial crisis the structure of balance sheets is very different. The debt-to-book assets ratio is lower. It was 60 percent in 2008 vs. 48 percent today. And when you look at market value, the ratio is only 29 percent.
In addition interest expenses relative to NOI have also declined dramatically. So REITs both have less debt and are paying lower rates on it. Also, the debt they are holding is termed out. The weighted maturity is currently 88 months—more than seven years. So, it’s lower expenses with longer maturities and less debt, which makes managing through a period of rising rates much easier.
WMRE: Does anything jump out at the property level among the month’s returns? Almost all segments were down.
John Worth: Infrastructure, which is basically cell towers, and data centers were the two that had the largest sell offs. They were down 13.58 percent and 13.89 percent. And then we saw industrial REITs down 8.41 percent. So, to the degree to which nearly all sectors were down for the month the sell off was particularly acute in the tech-based and ecommerce-driven sectors. There was a broader tech drawdown in the stock market. So perhaps there were some crosswinds that hit those REITs.
In addition, we are still going through this reopening despite the omicron wave and seeing strong retail sales. So part of this is also some of this cycling back. The differences in relative performance may be reflecting some of that.
The other thing to note is that the selloff was global in nature. When you look at the global REIT indexes we see Americas, Asia Pacific and Europe all had negative returns for the month of January.
WMRE: Looking forward, what are your expectations. We’re almost through REITs reporting annual results. So how will that factor in?
John Worth: Earnings have been strong. Many REITs are beating Wall Street estimates for FFO growth. So it’s been a good earning seasons. It’s one of these cases where you’ve got a bit of a divide in valuation and operating performance. Those two tend to converge in time.
We will put a full analysis together when all the reporting is done, but my expectation based on what we have seen so far is that actual operating performance was quite good and REITs are continuing their solid recovery.
WMRE: Last year was also very active in terms of equity and debt offerings. How is that looking right now especially in light of January’s numbers?
John Worth: We are going to see another strong year for capital markets. REITs are going to continue their expansion and acquisition strategies.
WMRE: Can you quantify how active REITs have been in terms of acquisitions and dispositions?
John Worth: In the third quarter of 2021—the last one we have full data for—REITs had gross acquisitions of $27 billion and dispositions of close to $12 billion. It came out to a total of about $15.5 billion in net acquisitions which followed on $18 billion in net acquisitions in the previous quarter.
You can get a sense of REITs’ views on the prospects for growth by the degree to which they are out in the market making acquisitions. In 2020, we saw net acquisitions of $22 billion for the year. In 2021, we had $36 billion in the first three quarters. Almost all of that—roughly $34 billion—took place in the second and third quarters. So as the recovery took hold, they got into to acquisition mode. And my expectation is we will continue to see that trend when the Q4 numbers are finalized.
WMRE: Are there any other themes before we wrap up?
John Worth: One last point is that we recently did a deep dive in sector results globally that we published as a market commentary.
When you look across the sectors and over the full COVID period of Feb 2020 through end of 2021, what you see is that North America outperformed Europe and Asia. During that whole period total returns in North American markets were more than 20 percent vs. 4.9 percent for Europe and vs. negative 4.5% for Asia.
One of real differentiators is that the U.S. REITs have a much larger share of industrial, data centers and infrastructure real estate and a larger share of self-storage. Those were some of the strongest segments and it underscores the degree to which the diversity of property sectors has been very helpful in supporting U.S. real estate and REIT markets. You don’t see that in some of the other global markets.
The other interesting thing is when you look at the office sector across all regions, the performance is quite close with a narrow spread. It underscores the degree to which these three different regions have had different performances in terms of the share of workers in offices without that having a big impact on results. Parts of Asia have been far more aggressive in bringing workforces back to offices. Europe and North America have been slower. The fact that you see such similar returns despite the different shares underscores that returns are not being driven by who is in office today, but a forecast of how offices will fare long-term.