New analysis of the 27 largest actively-managed real estate investment funds focused on REITs found that such managers increased allocations by over one percentage point in the healthcare and residential property sectors and by almost one percentage point for data centers.
Nareit began tracking actively-managed fund activity earlier this year.
According to the analysis, “All three sectors’ shares were up year-over-year as well in the second quarter. All three were also overweight in their share of fund assets under management compared to their share of the FTSE Nareit All Equity REITs Index.”
That finding was part of a busy month of research for Nareit. The association also published an analysis of REIT balance sheets, which found that REIT leverage levels remain relatively low with a high percentage of fixed rate and unsecured debt, as well as looks at REIT sustainability performance and its latest REIT ESG Report.
September, however, was another tough month for REIT performance, with the FTSE Nareit All Equity index suffering declines. Total returns were down 7.04% for the month. The index was also down 5.61% for the year, as of the end of September. The performance mirrored the broader selloff in equities markets for the month.
WMRE spoke with Edward F. Pierzak, Nareit senior vice president of research, and John Worth, Nareit executive vice president for research and investor outreach, about the recent reports, as well as September performance for REITs.
This interview has been edited for style, length and clarity.
WMRE: Let’s start with the active manager analysis. This is a relatively new bit of analysis that you have been doing, correct?
Ed Pierzak: This is the second follow on. I really like it. I think it’s neat for a variety of reasons. You are tracking the largest actively-managed REIT investors and seeing what they are doing. They give you a nice sense of what they believe is in favor or what they think will likely preform well in the coming quarters and years.
When you look at the Q2 results, I don’t think it’s all too surprising. Managers increased allocations to healthcare, residential and data centers. We provide a lot of statistics behind that. One of the things when we talk with not only investors but consultants is that there is often a lot of interest in what we would term the “modern economy sectors.” But when we look at the active manager analysis, we find the traditional sectors play an important role as well. Just shy of 60% is allocated to traditional property types. The highest, with 23%, is residential. Retail and industrial are at around 15% each. Office is all the way down at 3%.
One of the insights you get is that it identifies all of the constituents by sector in the index and also identifies how many REITs are owned by at least one of the active managers. As you look across the board, data centers and gaming only each have two potential REITs to invest in. Both REITs for both sectors are included in at least in one of the manager portfolios. When you look at retail, there are 34 constituents and 27 are found in active manager portfolios.
The last thing we’ve done is to see if there is a change in performance of a sector after a previous change in weight. What it shows is that there has been a positive relationship. A one-basis- point increase in weight is associated with a three-basis-point outperformance in the next quarter. And the same holds true in the other direction.
WMRE: Pivoting to the balance sheet analysis, in previous conversations you’ve stressed that REIT balance sheets are well-positioned, with relatively low leverage levels, average terms and a high reliance on unsecured and fixed rate debt. Are things holding well on those fronts?
Ed Pierzak: In today’s environment it couldn’t be more important. As we’ve described, REITs have low leverage and have been able to focus on fixed-rate and unsecured debt. The access to unsecured debt gives a competitive advantage. In recent conversations with investors you get a real sense of how challenging the mortgage market is today. Not only are there challenges, but in some instances you really can’t get debt.
If you look at REITs and their heavy use of unsecured debt, it puts them in a great place. This piece is a little more detailed than some of our more general reports. We pulled the curtain back and tried to look at the 13 sectors and look at different levels of leverage ratios. When we look across in aggregate, the leverage ratio is below 35%, but when we look at sectors, we find 9 of the 13 have it below 40%. That’s indicative of REITs following a core-like investment strategy. Only two sectors are in excess of 50%--office and diversified.
When we look at some of the other elements in terms of fixed rate debt, 11 of the 13 are utilizing greater proportions of fixed-rate today than compared to the GFC (Great Financial Crisis). It’s an indication that REITs have learned their lesson. We also find that 9 of 13 have unsecured to total debt ratios of 75% and even those that are among the lows—hotels/lodging for example—it is still at 60%. They can access a lot of capital and access it in a cost-effective matter. More than 85% of public equity REITs have an investment grade bond rating.
WMRE: So how does that compare to REIT balance sheets during the GFC?
Ed Pierzak: In aggregate, we are just under 35% today, but if you go back in time before the GFC in fact we had levels that exceeded 50%. Back in Q1 of 2009, leverage levels peaked at roughly 65%. So it’s really a dramatic difference. There’s a tremendous amount of discipline as it comes to REIT balance sheets today.
WMRE: Pivoting to the sustainability report, what were you looking to accomplish with this one?
John Worth: It’s a new study. Not anything like this has been done before. It’s a study that Nareit helped sponsor, but was completed by three academics and published in the Journal of Portfolio Management.
The first half looked at how REITs and private real estate perform in terms of key sustainability metrics, such as GRES data. It was looking at ODCE funds vs. REITs to get property type alignment. What they find is that even after they control for a number of explanatory variables like size, the number of years reporting, and others, they found in four of five attributes that REITs have statistically significant outperformance.
REITs statistically outperformed in overall GRES score, rank, performance score and building certifications. They also outperformed in management score, but it was not statistically significant.
What we take away from that part is that if you have sustainability goals, REITs are not going to detract. In fact, REITs in your portfolio will help you meet those goals.
WMRE: What was the second half of the report?
John Worth: The second half looked at whether REITs with stronger sustainability disclosures had a correlation with stronger financial performance. The authors are not making a causal argument. But it doesn’t appear that there is a financial cost to sustainability disclosures. So, we think it is an interesting study and that it is thought provoking. It affirms something we had believed for a while, which is that REITs are competitive with sustainability and that for investors with that as a criteria or priority, REITs can help them achieve those sustainability goals.
WMRE: So the last piece is the ESG report, which is something you put together annually. What is featured in that report and are you measuring annual improvements in these metrics?
John Worth: There’s a snapshot in the report of the great work in terms of ESG, as well as 20 case studies of some real world examples.
In terms of a year-over-year basis, we do see some incremental progress each year, but this also shows you the culmination of that progress over a longer period. It asks what were they doing in 2018 and what were they doing in 2022? And you see a huge increase over that period.
In every aspect, we have seen a lot of hard work and a lot of improvement in reporting and in terms of actually getting it done on the ground.
WMRE: Lastly, do you want to touch on September results? Last month I think we talked about REIT performance being down in-line with the broader market. Is that the case again?
Ed Pierzak: Both REITs and broad equity markets were down. REITs were down about 7%. The broad equity market was down about 5%. I think one of the other things to keep in mind is we did see a significant rise in the 10-year Treasury yield. Today it’s at 4.8%. As we span across from the beginning of 2023, it is a 100 basis point increase. That is a very significant movement in the Treasury yield.
The most challenging results were in the office sector, as well as diversified REITs. As you look at diversified, there are a couple of things to note. One is you will find office properties in there. You will also find a lot of triple-net leases. They are the most bond-like. So, as we see an increase in Treasuries, it’s not surprising to see some declines in values there.
