Whole returns for the FTSE Nareit All Fairness Index have been up 2.2% in June, placing the index down 2.1% year-to-date. It was the second consecutive month of progress for fairness REITs, with the all-equity index now practically recovered from a low level of being down practically 10% this spring.
The good points for the month have been broad-based with practically each property phase posting constructive returns. On the excessive facet, specialty REITs (up 7.8%), self-storage (up 7.3%) and residential (up 5.8%) have been the most important movers. Most different property sorts eked out good points with diversified REITs (down 7.6%), timberland REITs (down 5.1%) and telecom REITs (down 1.5%) being the lone exceptions.
For the yr, REIT efficiency has been tempered by ongoing inflation considerations and shifting expectations on fee cuts from the Fed. However with rising optimism for the potential of no less than one fee minimize earlier than the top of the yr, REITs stand positioned for a rally. That outlook is bulwarked by REITs retaining stable fundamentals and conservative steadiness sheets.
WealthManagement.com spoke with Edward F. Pierzak, Nareit senior vice chairman of analysis, and John Price, Nareit govt vice chairman for analysis and investor outreach, about REITs within the first half of the yr and the latest outcomes.
This interview has been edited for fashion, size and readability.
WealthManagement.com: What are your principal takeaways from this month’s returns?
Ed Pierzak: REITs have been up 2.2%, which is good to see. Once we make a comparability to the broader market, oftentimes our comparability is the Russell 1000. That was up 3.3%, so REITs traded a bit decrease than the broader market. While you look throughout the sectors, you will note constructive or close to 0% outcomes nearly throughout the board. One space with some challenges is timberland REITs. That’s a continuation of a development.
On the upside, we see sturdy efficiency in just a few areas. One among them is specialty REITs, up 8.0%. Quite a lot of that has to do with the sturdy efficiency of Iron Mountain, which is a doc and knowledge storage agency. That enterprise has been doing fairly effectively. They’ve additionally began some new initiatives, together with going into knowledge facilities. YTD, efficiency for Iron Mountain is up practically 32%.
We additionally noticed a bounce again in self-storage and residential, which was actually pushed by house REITs (up 6.8%). While you take a look at these two, self-storage demand drivers are interlinked with the residential sector. When flats do effectively, self-storage tends to do effectively.
With flats, there’s a level of softening with provide and demand, however lease good points have continued. One of many different parts we’ve got recognized by T-Tracker is that there’s fairly a big unfold in implied cap charges for house REITs vs. personal flats. It’s nonetheless about 190 foundation factors, which implies to the extent that you simply admire good worth, REITs within the house sector supply a possibility for additional good points within the sector.
WM: By way of total REIT efficiency for 2024, how a lot of that has been a mirrored image of traders reacting to shifting expectations on rates of interest and the state of inflation?
EP: Should you return to 2022, we discover an apparent development. As we’ve seen Treasury yields improve, REIT efficiency has declined and vice versa. In the present day, we’re getting extra readability, albeit expectations for fee reductions have modified. We had anticipated just a few fee cuts, and now we’re at some extent the place we predict one. However as there may be extra readability on the trail ahead, individuals are feeling extra assured.
WM: Taking a look at a few of the sector’s efficiency, I recall self-storage being an outperformer in previous years earlier than issues slowed down earlier this yr. Is that this a return to type? And what about residential?
EP: We began to see some sluggish demand, and as that fell off a bit it was coupled with provide not stopping. So, there was a bit little bit of a pause there. That’s beginning to bounce again.
With flats by way of occupancy and lease progress, flats have achieved very effectively. Oftentimes, we evaluate internet absorption with internet deliveries. We are going to do that on a rolling four-quarter foundation. You may take the straightforward distinction of these. Should you take a look at internet absorption much less internet deliveries you may see if there’s extra demand than provide. We noticed the demand measure peak within the latter half of 2021. It tumbled, and going by the second quarter of 2023, it hit a low level. Since that point, we’ve seen the demand facet choose up a bit bit.
It’s vital to notice that regardless of this, occupancy charges have remained north of 95%. It’s a really stable quantity in mixture and it permits you to proceed to push rents, though not on the similar tempo. There’s a little bit of tempering. While you hit double-digit lease progress, which we have been at, it’s simply not sustainable, nor would tenants admire that. So, it’s fallen off some, however there’s nonetheless energy there.
John Price: I might add that there are some similarities between self-storage and flats. They each carried out extraordinarily effectively in 2021 and 2022. Some new provide got here in with barely decrease demand. Now, we’re reaching an equilibrium.
WM: Nareit is publishing its midyear outlook this week. What are a few of the themes you’ve got recognized?
EP: Wanting again on the primary half, we had financial uncertainty and better rates of interest. Inside property markets, some fundamentals are waning, and there’s nonetheless a divergence between public actual property and personal actual property valuations.
The general financial system nonetheless has some inflation, however the job scenario appears good. We’re clipping alongside at a good tempo of financial progress. The outlook on whether or not we may have a recession has additionally modified dramatically from a yr in the past.
In response to the Bloomberg consensus forecast, solely 30% of economists say there shall be a recession within the subsequent 12 months. One yr in the past, it was 60%. Persons are a bit extra optimistic and see the financial system as a “glass half full” somewhat than a “glass half empty.”
That’s the scenario at the moment. We nonetheless see headwinds, and REIT returns have been muted within the first half of the yr, however we do consider that public REITs are well-positioned throughout a number of completely different parts.
Firstly, operational efficiency stays stable. REITs are experiencing year-over-year progress with funds from operations, internet working revenue (NOI) and same-store NOI. We have now nice numbers. Occupancy charges throughout the 4 conventional property sectors are excessive in an absolute sense, and so they have tended to outperform their personal market counterparts. That means that REITs have a prowess in asset choice and administration.
Secondly, REITs have continued to keep up disciplined steadiness sheets. They get pleasure from higher operational flexibility and face much less stress than their personal counterparts, who carry heavier debt masses and better prices. For REITs, the loan-to-value ratio is true at about 34%. The typical time period to maturity is 6 1/2 years, and the price of debt stays a bit over 4%. They’re additionally targeted on fixed-rate debt, at 90% of their portfolios, and 80% of their debt is unsecured.
A 3rd level is public REITs have continued to outperform. If we evaluate with ODCE funds, over the past six quarters, REITs have outperformed by practically 33%. But even with this outperformance, there’s nonetheless a large cap fee unfold of 120 foundation factors between the appraisal cap fee for personal actual property and the implied REIT cap fee. This vast hole is a suggestion that there’s extra gasoline within the tank for REIT outperformance within the second half of 2024.
The final principal level is that after we take a look at REIT occupancy charges and the pricing benefit they’ve and also you mix the 2, it is a chance for actual property traders. REITs supply extra for much less.
WM: On the third level, how a lot has the unfold between personal actual property and REITs tightened on this cycle?
EP: Within the third quarter of 2022, that unfold peaked at 244 foundation factors. So, it successfully has been minimize in half. It’s been gradual, seen in a historic context. Should you return to the Nice Monetary Disaster, the cap fee hole reached 326 foundation factors, but it surely absolutely closed within the following 4 quarters.
So, you would possibly ask, “What’s going on this time?” Quite a lot of the sluggishness is as a result of modest, measured, and doubtlessly managed improve within the appraisal cap charges on the personal facet. They’re taking a gradual strategy to adjusting values within the mid-single digits each quarter. They’re ready to see if the market will come to them somewhat than them coming to the market.
WM: Are you able to additionally quantify how a lot of the tightening that has occurred resulted from REIT enchancment in contrast with the appraisal cap fee coming down?
EP: Going again to the third quarter of 2022, the REIT implied cap fee was at 6.07%, and the personal appraisal cap fee was 3.63%. Quick ahead to at the moment, the REIT implied cap fee by Q1 was 5.8%, and the personal cap fee was 4.6%. So, on the one hand you may see the REIT implied cap fee has been considerably constant in its pricing whereas the personal cap fee has elevated by over 100 foundation factors.
