With Federal Reserve chairman Jerome Powell increasingly signaling a normalization in monetary policy and rate cuts expected to begin next month, total returns for the FTSE Nareit All Capital Index rose 12.5% to today in the third quarter.
This increase has pushed the index from negative territory to 10.0% for the year. Gains have also outperformed the broader markets, with the S&P 500 up 2.6% and the Russell 2000 up 7.07% over the same period.
Results were also driven by strong the second trimester results, which featured nearly two-thirds of REITs reporting year-over-year increases in net operating income (NOI), according to Nare's T-Tracker. Overall, NOI for all REITs increased 3.5% from a year ago, with same-store NOI up 3.0% year-over-year.
WealthManagement.com caught up 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 the latest developments in the REIT space.
This interview has been edited for style, length and clarity.
WealthManagement.com: Where do REITs stand for the quarter and what has driven recent performance?
John Worth: There was very strong performance for the quarter, with July and August both contributing to the trend. We've seen some notable sector outperformance, including offices up around 20%, self-storage up nearly 16% and telecommunications up 16.1%. Almost all sectors are updated on a quarterly basis.
WM: How does this compare to the broader markets?
JW: The all-cap index has significantly outperformed the S&P 500 and NASDAQ even when compared to something like the Russell 2000, which is up more than 7%. This is very consistent with historically when you go into an easing cycle, you get REIT outperformance. Many returns have come as markets have become increasingly convinced that cuts are coming in September and this is reflected in REIT returns.
WM: Given these numbers, is there additional runway for REITs, or are rate cuts now priced in?
JW: Some of what we have seen reflects the prospect of rate cuts and monetary policy normalization. But we've also had an earnings season where operational performance has continued to be strong. And REIT balance sheets are strong. So the results reflect the operating performance and the easing rate environment.
WM: Can you talk more about the REIT's second quarter results? What were some of the highlights here?
Ed Pierzak: Both NOI metrics – NOI and same-store NOI – increased 3.5% and 3.0%, respectively. These are stable operational metrics. And when you talk about the divergence between implied REIT capital rates and the private valuation cap rate as reflected in the ODCE index, the difference still stands at 130 basis points. This is certainly another signal that REITs have more fuel in the tank. We're seeing some of that compression now with the anticipation of rate cuts, but we'll likely see more once the cuts start as well.
WM: You also just published an article examining the balance sheets of REITs. Can you talk about the analysis in that part and what that means for the sector?
EP: It gives people a sense of how disciplined REITs have been and how positioned they are. There is always a lot of talk about the potential for opportunistic acquisitions because of that gap between the public and private markets. We haven't seen a large number of transactions yet. But we know that REITs are in the catbird country. The operations are looking great and so are the balance sheets. REITs have low leverage ratios at 34.1%. They have many maturities of six and a half years. And the average cost of debt is 4.1%.
When you look at the composition, all 13 sectors have more than 50% of their debt as fixed rate and unsecured. Some sectors are tilted close to 100% on both. This gives a lot of flexibility in operations, and with the opportunities that come up, they will be able to get involved and take advantage.
REITs have also been able to dip into and issue debt as needed. In the second quarter alone, REITs issued $12.5 billion in unsecured debt, with average rates at 4.5%. When you look at the average 10-year Treasury yield, it was 4.4%. REITs have been quite adept at when rates have fallen, they have been quick to issue new debt.
WM: With this widespread expectation of a rate cut, will this create more opportunities for REITs to issue new debt?
EP: They can move to the margins, but I don't think they will get a position where they will grow. They have a long-term investment horizon. Everything they are doing in terms of the amount of leverage, the maturities and the use of fixed rate debt is all consistent with the long term horizon. That should make REIT investors feel good. REITs are not chasing potentially low rates or quick returns, but investing for the long term.