On the heels of a rough month of April, the FTSE Nareit All Equity REITs Index mounted a comeback in May with total returns up 5.29%. Year-to-date, total returns for the index stood at -4.31% at the end of May, up from -9.11% as of the end of April.
The results followed REITs’ first quarter earnings season. On operations, more than two-thirds of REITs reported year-over-year increases in net operating income. NOI increased 2.8% from 2023, and same-store NOI rose 3.2% year-over-year. In addition, average REIT occupancy remained stable at 93.2%, and REIT funds from operations was up 1.0% compared to a year ago.
REIT balance sheets also remain healthy, with nearly 80% of REIT total debt as unsecured and nearly 90% locked in at fixed rates. Leverage ratios stand at 33.8%, considerably lower than REIT debt loads during the Great Financial Crisis.
The weighted average term to maturity on REIT debt is 6.5 years, and the average interest rate is 4.1%.
This provided a backdrop for this week's Nareit’s annual REIT Week conference. More than 90 REITs presented at the event, which had more than 2,500 attendees.
WealthManagement.com spoke with Edward F. Pierzak, Nareit senior vice president of research, and John Worth, Nareit executive vice president for research and investor outreach, about REIT Week and REITs’ most recent results.
This interview has been edited for style, length and clarity.
WealthManagement.com: You are 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 bit is that we’ve often talked about REITs’ solid balance sheets. In a lot of presentations firms say they are maintaining that focus. They think balance sheets are in good shape but are also talking about further refinements. In a time of “higher-for-longer” interest rates, the 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 transactions market open. REITs are on their front feet and will more likely be acquirers. They have strong balance sheets and access to equity and debt. Coming out of real estate slumps, REITs tend to be early movers into those market cycles in part because they tend to be more disciplined.
WM: Can you tease out a bit about what happened with May’s results? The numbers seem strong across the board, with some sectors posting double-digit or near double-digit returns.
EP: The monthly numbers look quite good, with the all-equity index up around 5%. On the year, the index is still down, but ahead of the Russell 2000. For individual property sectors, for the most part, they all posted gains and, in some instances, 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 logged earlier in the year.
Industrial REITs also did well, and having attended a few of the presentations this week, managers in that sector feel really good. Occupancy rates are solid, and there is a positive sense of prospects going forward.
WM: With the industrial sector, the context here is also that the segment had a particularly high peak in the most recent cycle with near 0% vacancy and very strong rent growth. So, some of the recent performance represents a drop from those peaks, but we’re not talking about a massive step backward. Correct?
EP: I was going to say that with industrial, as you said, it really got to a point where we were looking at double-digit year-over-year rent growth. That’s not sustainable. Even as we’ve seen a degree of softness, the occupancy rate is north of 96% for industrial REITs. The buildings are full, and when we talk about some weakening, it’s at the margins.
Looking at T-Tracker, occupancy rates in three of the four major project sectors exceed 95%. The exception is, of course, offices. Even the office occupancy rate stands at 88%. We’re getting to a point where we’re seeing fewer material drops, and it’s been hovering at that 88% range for a few quarters now.
WM: Is there anything else that stands out from the Q1 T-Tracker?
EP: There’s still a lot of strength there. Year-over-year numbers on FFO and same-store NOI continue to be positive. With FFO, numbers were north of 1%. And that was impacted by what we saw in the healthcare area. Excluded healthcare, that number would pop up to 6%. So, operations look good, and occupancy rates look solid.
We also recently published a commentary that outlines that when we look at balance sheets, one of the points we look at is the leverage ratio. It’s still at 33.8%. It’s akin to a lower-risk investment strategy on the private side.
In addition, there is the interest expense to net operating income ratio. And that’s just a little over 20%—20.8%, to be exact. What it effectively shows is that debt is not proving to be a burden. NOI is the money you have for dividends, expenses, renovations, etc. So even though people are talking about higher for longer interest rates, REITs aren’t stressed operationally by that.
WM: And for historical context, how do those ratios compare to previous cycles?
EP: On the leverage ratio and interest expense ratio, we’ve seen a marked decline in both measures since the Great Financial Crisis. It’s nearly cut in half on the leverage ratio, and the interest expense to NOI ratio has followed a downward trend. Both trends are good. REITs learned a lot of lessons from the GFC and made a strong effort to not let what happened then happen again.
WM: Any additional highlights since our last conversation?
JW: Something we hit on briefly last month, but that is worth hitting on again, is the study we did with CEM Benchmarking on the role of REIT distributions and how REIT active management has generated alpha.
Before fees, REITs and private real estate can both generate alpha. But on a net basis after fees, private real estate is destroying alpha. REIT strategies are outperforming private real estate across the distribution of returns, including at the median, at the 75% percentile and at the 90th percentile.
We think this is important. We hear from investors that they only use top-quartile private managers. Identifying top-quartile private managers is a great skill to have. But if you can identify top-quartile REIT managers, that’s going to get you even greater returns.
Some recent surveys of institutional investors found that about 10% understand that REITs have historically outperformed private real estate. About 45% believe it’s about the same. However, academic evidence and practitioner research show REIT outperformance. We may take it for granted, but many investors may not understand the relative performance characteristics of listed vs. private real estate.
