The US inflation rate rose on average in March with the personal consumption expenditure price index and the core PCE price index each up 0.3%. Annual inflation remains close to 3% rather than the Fed's target of 2%. Those numbers, along with near-record low unemployment, have dampened expectations of when the Fed might cut rates. At the start of the year, markets were expecting up to three rate cuts before the end of 2025 starting in March. Now some believe the Fed will not reach its target until September.
The changing outlook weighed on publicly traded REITs, with the FTSE The Nareit All Equity Index saw total returns fall by 7.91% in April. This pushed the year-to-date number to -9.11% at the end of April.
Almost every property sector suffered some declines. Apartment REITs (up 2.26%) and healthcare REITs (up 0.86%) were the only exceptions, driving increases in total returns. Meanwhile, year-to-date specialty REITs — a somewhat elusive category for extremely niche property sectors — are up 7.43%, joining apartment REITs (up 2.72%) and REITs single family rentals (up 0.79%) as the only segments in positive territory.
On the downside, industrial REITs had the worst month (down 18.87%) and performed worst year-to-date (down 20.90%).
WealthManagement.com spoke with John Worth, Nare's executive vice president of investor research and outreach.
This interview has been edited for style, length and clarity.
WealthManagement.com: Can you put the monthly and year-to-date numbers in context? Was this a case of wider economic factors driving the numbers down?
John Worth: It's a continuation of a theme we've seen over the past 18 months, where REITs are macro-driven in the sense that they are driven more by interest rates than by their individual or collective operating performances.
In April, we saw the 10-year rise from 4.3% to a peak of 4.7% before tapering off slightly. This lowered the REIT's valuations. The all-equity index fell 7.9% for the month, bringing it down to -9.1% on a year-to-date basis.
So far in May, there has been some rate moderation and a bit of a REIT recovery. The index is up around 3% so far in March, and the year-to-date figure has improved to -6% as the 10-year retreated to a high of 4.4s.
What gives us some comfort about this is that we know that REITs are prepared for a period of high interest rates. Their balance sheets are healthy. They have paid off their debt, reduced the amount of debt on their balance sheet, and the capital markets are open for REITs. They have been able to issue equity and debt. They are suitable to perform during this period.
Overall operational performance has been good. And when we get to the normalization of interest rate policy, historically, we've seen those as periods in which REITs not only recover, but outperform.
WM: You talked about how the macro environment has affected total returns, and it's pretty much across the board. But does anything stick out when you drill down into different property sectors?
JW: There are some concerns about the industrial/logistics sector and the slowdown in demand growth and how quickly it will recover. This can boost the performance of some sectors. Industry is the worst performing sector year after year
WM: I noticed that data centers and telecommunications were also hit. We've talked in the past about how some of these “new economy” sectors have performed well and been popular with investors. What is going on with these segments?
JW: We have seen that telecommunications have underperformed the index last year and this year. Basically, a lot of what's going on has concerns about how quickly demand for telecom towers is growing. The sense from earnings season is that there will be renewed demand coming later this year and next year.
For data centers, which were the best-performing sector last year, it's a bit of a letdown after a really strong run.
WM: You mentioned that REITs have still been able to raise debt and equity when they wanted to. What have they done so far in 2024?
JW: In the first quarter, REITs raised $17.9 billion in secondary debt and equity offerings, with debt issuance accounting for about $13 billion of that. Most of the rest of that overall figure came from ordinary equity issues. What it does not capture is “to market” emissions. We catch that figure in a delay. So the total emission was probably slightly higher.
The first quarter figure was significantly higher than the fourth quarter of 2023 and slightly higher than the first quarter of 2023. At the beginning of the year REITs saw it as a good time to enter the market. There was a lot of issuance with interest rates and corporate spreads compressed.
In this period, when the rate environment was attractive, we saw REITs issuing debt and taking care of some refinancing. Because of the structure of REIT balance sheets, they have been able to pick and choose when to go to market. They have not been forced to increase the debt. They are able to find these opportune moments to enter. It was really busy so far this year and once we saw rates go up, issuance slowed down again.
WM: We are also approaching the next T-Tracker that summarizes quarterly results. What are you seeing from what has been reported so far?
JW: Our feeling is that this will be a good quarter. We are seeing a continuation of Q4 2023 with REITs posting solid operating performance on a YoY basis. In the context of a slowing economy and a somewhat slowing commercial real estate market, REITs are continuing to post year-over-year rent growth and NOI growth at or above the rate of inflation and paying meaningful dividends that are growing over time. They have been able to maintain their occupancy levels.
We made one recent market commentary comparing the occupancy rates you see for REITs and what you see in ODCE funds. It highlights that across property sectors, REITs have the highest occupancy rates, signaling the relative quality of their real estate holdings.
With balances, we've also seen more of the same recent trends in terms of strength of balances. It remains low leverage ratios, long weighted average terms to maturity and a weighted average interest rate that is under control and reflects the high proportion of REIT debt that is fixed rate and unsecured.
This ratio will be consistent with our view that REITs have the balance sheet capacity to operate at higher rates, but that they are also delivering solid operational performance.
WM: With the last T-Tracker, there was also the telling that while there is still growth in many of the fundamental metrics, the pace of growth has slowed. Do you see any further slowdown this quarter?
JW: We're not at the end of the process yet, so it's hard to say whether the year-over-year FFO and NOI growth rates are higher or lower. Right now, they look pretty comparable and I'm not sure we'll see a sustained decline this quarter.
WM: I understand you also have a new study being launched evaluating actively managed portfolios. Can you talk about that?
JW: This is a study from CEM Benchmarking, which I know we've told you about before. It's a little bit different and an extension and expansion of the CEM studies you've seen before, which have asked on average what the returns of different asset classes are. What we've pointed out before is that when you look at 24 years of data, you see that REITs outperform private real estate by an average of 2 percentage points per year.
The new study asks a slightly different question. He is looking at what the returns or added value are for active management for REITs and private real estate and how they differ across distribution channels.
On a gross fee basis, before accounting for expenses, both REITs and private real estate create value relative to benchmarks. For REITs it is up 84 basis points and private real estate up 101 basis points. However, without fees, you see a difference. REITs outperformed by 32 basis points, while private real estate underperformed by 68 basis points. Fee drag in the private real estate space affects the net performance that investors ultimately receive.
One of the other things that is different is that we can see that distribution of returns. And between the 10th percentile and the 90th percentile and even a little bit above, we see REITs outperforming all those percentiles.
It comes down to what is often a question discussed by real estate investors about how to think about top managers. A frequent discussion when looking at public vs. private is that plan sponsors will say, “We understand that private real estate underperforms on average, but we only use top quarter managers.”
What we found here is that even among top quartile and decile managers, active REIT management outperforms private real estate. If you are able to identify those top quartile/decile managers in the REIT space, it will provide higher returns than the top managers in the private real estate space.
We think the audience for this is mostly in the institutional space, where we think it's an important component of why institutions should use REITs and private real estate together, to use all the tools.