Regulatory & Compliance | 02.28.23
After Rough Year, REITs Readjust
by: Rich Blake
As an inflation hedge, real estate investment trusts (REITs) didn't report for duty last year.
Indeed, 2022 goes down as the second-worst year for the performance of publicly traded REITs since they began listing on exchanges more than three decades ago. S&P's most widely followed REIT index fell 24%.
Double digit declines for REITs only happened in four other previous years: 1990, 1992, 1994 and 2008.
Advisors might not want to write off their real estate holdings just yet, though, particularly when taking a long-term view. As for the short run, REITs, alongside equities, appear to be rebounding.
As of mid-month, the S&P 500 index had gained 8%. Meanwhile, S&P's REIT index rose 10% during those same first six weeks of the year.
Rising interest rates and the possibility of recession continue to weigh heavily. On a rolling 12-month basis, the benchmark REIT index remains down 8%.
Apartment Sector Resurges
REITs can serve as a hedge against inflation but allocators need to adopt a long-term time horizon if they expect to have success buying and holding securitized exposures to properties such as senior living complexes and medical offices.
Publicly traded apartment owner/operators fared exceptionally well to start the year as evidenced by the Bloomberg Apartment REIT index which produced a 12% return between Jan. 1 and Feb. 14. This rebound follows a historically terrible year for apartment REITs.
One trend spotted in the apartment sector has to do with demand for corporate-owned luxury rentals as younger, work-from-anywhere professionals migrate away from the Northeast, said Andrew Barber, a high-net-worth asset advisor in Corning, N.Y., and also publisher of Gravity Exists magazine.
Macro forces — inflation, rates, both possibly going higher, resulting in an economic slowdown — will largely determine whether the overall REIT recovery trend continues going forward.
A Perilous Fork
During periods of market turmoil over the past two decades, publicly traded REITs did not provide a hedge against inflation, and even detracted from diversification objectives, according to Institutional Investor, citing a paper released this month by the Swiss Finance Institute.
The REIT sector's hedging abilities inexplicably disappeared during the global financial crisis, the dot-com bubble and the COVID-19 pandemic, the SFI researchers found, noting, however, that this is a short-term phenomenon.
"Real estate in a portfolio can be an effective inflation hedge, provided investors hold the investment beyond a crisis," Institutional Investor said.
The REIT market seems to be at a perilous fork in the road right now. The U.S. housing market has been rocked by relative sky high mortgage rates, causing home prices to fall, spooking sellers.
One high-net-worth advisor told BISA Portfolio that generally heading into the year there was a growing sense of concern regarding the possibility of a scenario similar to 2008 when rising household debt levels compounded by interest rate hikes caused demand in the housing market to dry up.
A solid January for new home sales would seem to suggest the market is stabilizing.
This Time It’s Different
Daken Vandenburg, head of investments at MML Investors Services, recently offered his outlook on the potential for another housing crisis.
“We are now at a point where, between the combination of home prices and mortgages rates, it is now more expensive to own a home than right before the global financial crisis occurred," Vandenburg said. "It is tempting, as many pundits have done, to confuse correlation with causation, and claim that we will see a similar level of crisis as we did in 2008. While we are never confident enough to predict with certainty, there are several things that make this markedly different than the period before the global financial crisis."
First and foremost, he explained, there is much less consumer leverage in the system.
Also, wages have increased rapidly amidst a robust job market, which further reduces the risk that homeowners are forced to sell urgently.
REITs making something akin to a comeback in 2023 after a harrowing 2022 is possibly a harbinger of the so-called soft landing that some economists see as being unlikely but still plausible. Real estate tends to be the canary in the coal mine in times of excess.
REITs finance, own and oversee all kinds of property; money gets made from sales and rents. Most REITS also pay shareholders generous, reliable cash dividends.
Heading into 2023, REITs are sitting on strong balance sheets, according to Hazelview Investments' annual global public real estate report.
"The best long-term returns are typically generated when REITs are bought at discounts to their intrinsic value and when investor sentiment is at its lowest," said Corrado Russo, Hazelview's head REIT portfolio manager.
"History may not always repeat itself," he added. "But global REITs have averaged a 35% gain following years of double digit declines."
Over the past ten years, as of Feb. 24, 2023, the S&P USA REIT USD Total Return Index has produced a return of 8% on an average, annualized basis, versus 13.7% for the S&P 500 index of blue-chip stocks.
For bargain hunters, one of the REIT sub-groups hit hardest by the pandemic lockdowns was the commercial segment.
According to Kastle data, the return-to-the-office trend is underway with occupancy trending upward, but still well below pre-pandemic levels.
In a note to clients earlier this month, Strategas’ analysts Nicholas Bohnsack and Jason DeSena Trennert expressed doubts: “Commercial real estate has and will continue to be under significant pressure as the real economy is restarted,” they said. “We are skeptical of office REITs."