On the heels of one the difficult month of April, the FTSE Nareit All Equity REITs Index rebounded in May with total returns of up to 5.29%. Year-to-date, total returns for the index stood at -4.31% at the end of May, down from -9.11% at the end of April.
Results followed REIT' first quarter earnings season. In operations, more than two-thirds of REITs reported year-over-year increases in net operating income. NOI grew 2.8% from 2023, and same-store NOI grew 3.2% year over year. Also, average REIT occupancy remained steady at 93.2%, and REIT funds from operations increased 1.0% compared to a year ago.
REIT balance sheets also remain healthy, with nearly 80% of total REIT debt as unsecured and nearly 90% locked in fixed rates. The leverage ratio stands at 33.8%, significantly lower than REIT debt loads during the Great Financial Crisis.
The weighted average term to maturity for REIT debt is 6.5 years and the average interest rate is 4.1%.
This provided a backdrop for this week's annual Nare REIT Week conference. More than 90 REITs presented at the event, which had more than 2,500 attendees.
Asset management.com spoke with Edward F. Pierzak, Nareit's senior vice president of research, and John Worth, Nareit's executive vice president of investor research and outreach, about REIT Week and the latest REITs results.
This interview has been edited for style, length and clarity.
WealthManagement.com: You're joining me in the middle of REIT Week. How is the conference going?
Ed Pierzak: One of the things that's starting to resonate a little bit is that we've often talked about the solid balance sheets of REITs. In many presentations, firms say they are maintaining this focus. They think the balances are in good shape, but they are also talking about further improvements. In a time of “higher for longer” interest rates, sentiment remains positive.
John Worth: I echo that. Strong balance sheets, strong operational performance and strong numbers in May have put people in a positive frame of mind. At some point, we will also see the property transaction market open. REITs are on their front legs and are more likely to be buyers. They have strong balance sheets and access to capital and debt. Coming out of real estate downturns, REITs tend to be early movers in those market cycles in part because they tend to be more disciplined.
WM: Can you tease a bit about what happened with May's results? The numbers look strong across the board, with several sectors posting double-digit or near-double-digit returns.
EP: The monthly numbers look pretty good, with the all-cap index up around 5%. On the year, the index is still down, but ahead of the Russell 2000. For the individual property sectors, for the most part, all have posted gains and, in some cases, those gains are really quite strong.
Telecom REITs, for example, posted double-digit total returns. It's a bit of a rebound from the losses the segment recorded earlier in the year.
Industrial REITs also did well, and after attending some of the presentations this week, managers in that sector are feeling really good. Occupancy rates are stable and there is a positive sense of outlook for the future.
WM: With the industrial sector, the context here is also that the segment had a particularly high peak in the most recent cycle with about 0% vacancy and very strong rent growth. So some of the recent performances represent a drop from those peaks, but we're not talking about a massive step back. Correct?
EP: I would say with the industry, as you said, we got to a point where we were looking at double-digit rent growth year over year. This is not sustainable. Although we have seen some degree of softness, the occupancy rate is north of 96% for industrial REITs. The buildings are full and when we talk about a weakening, it is borderline.
Looking at T-Tracker, occupancy rates in three of the four main project sectors exceed 95%. The exception is, of course, offices. Even the office occupancy rate is 88%. We're getting to a point where we're seeing less material decline, and it's been in that 88% range for several quarters now.
WM: Anything else that stands out from the Q1 T-Tracker?
EP: There is still a lot of strength there. Year-over-year FFO and same-store NOI numbers continue to be positive. With FFO, the numbers were north of 1%. And that was influenced by what we saw in the health care field. Excluding health care, this number would go up to 6%. So operations look good, and occupancy rates look stable.
We recently published another one Commentary which describes that when we look at balance sheets, one of the things we look at is the leverage ratio. It is still at 33.8%. It is similar to a lower risk investment strategy on the private side.
In addition, there is the ratio of interest expense to net operating income. And that's a little over 20% – 20.8%, to be exact. What it effectively shows is that the debt is not turning out to be a burden. NOI is the money you have for dividends, expenses, renewals, etc. So even though people talk about higher for longer interest rates, REITs are not operationally stressed by this.
WM: And for historical context, how do those reports compare to previous cycles?
EP: In the leverage ratio and the interest expense ratio, we have seen a marked decline in both measures since the Great Financial Crisis. It has almost halved in the leverage ratio and the interest expense to NOI ratio has followed a downward trend. Both trends are good. REITs learned many lessons from the GFC and made a strong effort to prevent what happened from happening again.
WM: Any other highlights since our last chat?
JW: Something we got to briefly last month, but worth a shot again, it's the study we did with CEM Benchmarking on the role of REIT allocations and how active REIT management has generated alpha.
Before fees, REITs and private real estate can generate alpha. But on a net basis after fees, private real estate is destroying alpha. REIT strategies are outperforming private real estate across the entire distribution of returns, including the median, the 75% percentile, and the 90th percentile.
We think this is important. We hear from investors that they only use top tier private managers. Identifying top tier private managers is a great skill to have. But if you can identify the top REIT managers, it will bring you even greater returns.
Several recent surveys of institutional investors found that about 10% understand that REITs have historically outperformed private real estate. About 45% believe it is about the same. However, academic evidence and practitioner research show good REIT performance. We may take it for granted, but many investors may not understand the relative performance characteristics of listed versus private real estate.