The long-awaited arrival of lower interest rates last month helped push the FTSE Nareit All Equity REITs index up 3.2% as REITs continue a strong streak that has seen the index rise 39.1% since October 2023.
In the third quarter alone, total index returns increased by 16.8%.
Gains were broad-based, with only residential REITs down slightly (0.8%). Data centers (up 6.8%), specialty REITs (up 6.0%) and office REITs (6.7%) led the way. The index outperformed the broader stock indexes, which generally posted gains of 1% to 2% for the month.
The shift to a new interest rate regime could also finally narrow the shift that has been ongoing between the public and private real estate markets in recent years, especially as it could help open up the stagnant market for investment property sales. commercial real estate.
WealthManagement.com spoke with Ed Pierzak, Senior Vice President of Research Nareit on the latest results, what the rate cut could mean for the narrowing gap between public and private real estate markets, and recent changes in allocations by active REIT managers to various sectors of properties.
This interview has been edited for style, length and clarity.
WealthManagement.com: We now have the long-awaited arrival of the rate cut. What would this mean for September's results and the long-term outlook for REITs as we enter a new interest rate regime?
Ed Pierzak: It's good to share good news. The last time we talked about how there had been an increase since the end of the second quarter. We saw it materialize in July and August, and it continued into September.
Total returns for the all-cap index totaled 16.8% for the quarter. It is similar to the level of returns we saw in the last quarter of 2023. This strong performance came from the end of monetary policy tightening.
And in this most recent quarter, it wasn't just about rates themselves falling, but the expectation of a fall. By the middle of the year, there was much thought and sentiment that the FOMC would cut rates. The 10-year Treasury fell. Ultimately, they lowered the rates and we had this strong performance.
Across all property sectors, performance has been quite good. Offices in the quarter showed the strongest performance in all sectors, only 30%. There is often a look and perspective to the office where everything is painted with the same brush. However, REIT-owned office buildings have done better because they are well-located and highly regulated.
WM: Another topic we've been talking about over and over and you recently published an update on is the gap between estimated private real estate equity rates and the implied rate of the REIT index. The gap has narrowed over time, but it still remains. Will we finally see more convergence?
EP: The expectation is that the gap we've seen, which recently stood at 130 basis points, will halve, if not more.
This gap corresponds to what we would call the “non-divergent period”. Equity rates are not always in sync, but a convergence will be good news.
With the markets back in sync, the expectation is that we will see a revival in transaction volume. In a lower rate environment, pricing will make sense for the public/private sector and we are likely to see more transactions.
One of the things we've talked about is that REITs have been in a good place in terms of their balance sheets. They are ready for growth opportunities, be it through larger transactions or one-off deals. With our recent numbers out of the equity markets, we can see that they are well positioned.
Going back to the second quarter of 2024, REITs issued $12.5 billion in unsecured debt. And then, in the third quarter, they took out $15.4 billion. They have done so at an attractive rate. Next quarter should be an interesting time. There is little fuel in the tank for REITs to outperform for the remainder of the year. And for increasing activity.
We also had Lineage (a REIT that owns temperature controlled warehouses) conduct the largest IPO of the year in July. Then Equinix announced one new and more popular partnership institutional investors (GIC and Canada Pension Plan Investment Board). Their plan is to pursue $15 billion in new opportunities.
With examples like these, we're starting to see things moving along a bit.
WM: Nareit also recently published an update on his efforts for it track actively managed real estate fundswhich provides some visibility into which property sectors they are entering and how they are adjusting allocations over time. What did you find in this new update?
EP: One place I like to look are charts that capture the share of property sectors in actively managed funds against the FTSE all-cap index. Charts show overweights and underweights relative to the index of specific sectors. It's a bit behind what it is for Q2, but it gives some insight into where active managers are placing their bets.
In the current layout, overweights are in residential, data centers, telecommunications, gaming and healthcare. (Sectors underweight relative to the FTSE index include accommodation/resorts, offices, retail and self-storage)
Housing has gone well. Granted, there are some issues on some current bases, with demand not keeping pace with supply. With data centers, they will play a critical role in the future. Health care is the usual story. With the silver tsunami, people go to the doctor more or use senior housing more.
WM: What about quarter-to-quarter and year-to-year changes in allocations? Does anything stand out there in terms of what the active managers have been doing?
EP: Health care showed the largest quarter-over-quarter growth and was among the biggest year-over-year gains. I think, again, it's a recognition of the demographics and the fundamentals that we have. The medical office in particular, from my days on the private side, was always seen as a climbing rent. Doctors don't tend to move offices. And with senior housing, there are many different elements in terms of the spectrum of care, and these are things that people need more and more.
WM: And looking at some of the others, data centers and telecom, for example, we've talked in the past about some investors reallocating to be more reflective of the new shape of real estate rather than the traditional four sectors. So this seems to fit that theme, right?
EP: Indexes provide a great picture, especially if you look at time. You see innovation and you see the introduction of new sectors. If you look at the whole way we live, you're doing more things online, we're more connected. Real estate is much more than the four traditional types of property, and this is reflected in the index and the way the funds are invested.