The major rebound that REITs experienced in 2021 was always going to be an uphill task, but a nearly 8 percent drop for the month was not on anyone’s mind.
The FTSE Nereit All Equity REIT Index rose 41.3 percent in 2021 — the best single-year gain since 1976. Expectations for 2022 were strong fundamentals at a solid operating level and REITs will enjoy higher returns. And that attitude has changed. But the all-equity index fell 7.93 per cent for the month amid a sell-off in the broader stock market in January, with virtually no assets exempt from the fall. (The lone exception were health care REITs that reported a 0.19 percent gain for the month).
Some sub-sectors reported double-digit percentage declines, including infrastructure (down 13.89 per cent), data centers (down 13.58 per cent) and manufactured homes (down 10.37 per cent).
WMRE sat down with NAREIT executive vice president and economist John Worth to discuss January returns.
This interview has been edited for length, style, and clarity.
WMRE: Looks like it was a tough month. Can you tell us what these results mean?
John Worth: It was a significant sell-off. Probably the real driver for most of them was the one delivering the broader stock market returns. We saw the S&P 500 fall more than 5 percent for the month. This is largely a response to the Federal Reserve’s desire to tighten monetary policy and its impact.
What’s important to keep in mind when we think of REITs and interest rate changes are two broad concepts. REITs have been very resilient to long-term treasury changes over the past 25 years. If you look at REIT returns over a one-year period when Treasury rates are rising, you’ll find that REITs have risen by 80 to 85 percent over those periods.
The underlying point is that it is not just changes in monetary policy, but the context of why those changes are taking place. If monetary policy is changing and rates are rising, it is because of a strong economy. This is one context in which REITs in general tend to do well. Therefore, it’s important to think about how a REIT performs in a growing-rate environment over a one-month horizon.
WMRE: And as we’ve discussed in previous conversations, REIT balance sheets are in a strong position right now relative to other periods, right?
John Worth: Every time rates start to rise, the question arises of how much leverage the REIT is generating. If you look at REITs today compared to before the financial crisis, the structure of the balance sheet is very different. Debt-to-book asset ratio is low. It was 60 percent in 2008 vs. 48 percent today. And when you look at the market value, the ratio is only 29 percent.
In addition, interest expense relative to NOI has also declined dramatically. Therefore, both REITs have less debt and they are paying lower rates on it. Along with this, the debt which is on them also ends. Weighted maturity is currently 88 months – over seven years. So, it is low expense with longer maturity and less debt, which makes management much easier during periods of rising rates.
WMRE: Does the asset level bounce anything between the month’s returns? There was a decline in almost all segments.
John Worth: Infrastructure, which are basically cell towers, and data centers were the two that had the biggest sales. They were down 13.58 percent and 13.89 percent. And then we saw industrial REITs down 8.41 percent. Therefore, to the extent that almost all sectors declined for the month, selling was particularly intense in the tech-based and e-commerce-driven sectors. There was widespread technical fallout in the stock market. So there were probably some crosswinds that affected those REITs.
In addition, we are still in the process of reopening despite the Omicron wave and strong retail sales. So part of it is also some of this cycling back. Differences in relative performance may reflect some of them.
The other thing to note is that the sell-off was global in nature. When you look at the global REIT index, we see that the Americas, Asia Pacific and Europe all gave negative returns in the month of January.
WMRE: Looking forward, what are your expectations. We’re almost certainly reporting annual results through REITs. So how would that factor?
John Worth: Earnings have strengthened. Many REITs are trailing Wall Street estimates of FFO growth. So it has been a good earning season. This is one of those cases where you’ve got a slight split in valuation and operational performance. They both converge over time.
We’ll put together a full analysis when all the reporting is done, but based on what we’ve seen so far, my expectation is that the actual operating performance was pretty good and the REITs are continuing their solid recovery.
WMRELast year was also very active in terms of equity and debt offerings. What is it looking like right now especially in light of the January numbers?
John Worth: We are going to see another strong year for the capital markets. REITs are going to continue with their expansion and acquisition strategies.
WMREQ: Can you measure 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 — the REIT had gross acquisitions of $27 billion and disposals of close to $12 billion. It accounted for approximately $15.5 billion in total acquisitions, up from $18 billion in net acquisitions in the previous quarter.
You can get an understanding of REITs’ views on growth prospects by looking at the extent to which they are taking over in the market. In 2020, we saw net acquisitions of $22 billion for the year. In 2021, we had $36 billion in the first three quarters. All of that—about $34 billion—happened in the second and third quarters. So as the recovery kicked in, they got into takeover mode. And I expect we’ll continue to see that trend when the Q4 numbers are finalized.
WMRE: Is there any other theme before we are finished?
John Worth: One final point is that we recently took a deep dive into global sector results that we published in the form of Market Commentary.
When you look at all regions and the entire COVID period from February 2020 to the end of 2021, you see that North America has outperformed Europe and Asia. Overall returns in North American markets were more than 20 percent versus 20 percent during that entire period. 4.9 percent for Europe and Vs. Negative 4.5% for Asia.
One of the real differentiators is that U.S. REITs own a large proportion of industrial, data center and infrastructure real estate and a large proportion of self-storage. Those were some of the strongest segments and this underscores the degree to which the diversity of property sectors has been very helpful in supporting the US real estate and REIT markets. You don’t see that in some other global markets.
The other interesting thing is that when you look at the office area in all respects, the display is pretty close with a narrow spread. This underscores that these three different sectors have had different performances in terms of labor share in offices, without having a major impact on the results. Some parts of Asia have been more aggressive in bringing the workforce back into offices. Europe and North America have been slow. The fact that you see such similar returns despite individual stocks suggests that the returns are not in office today, but rather a forecast of how the office will perform over the long term.
