The continued strength of commercial real estate as a sector, combined with the disciplined strategies of REIT management teams in recent years, has left publicly-traded REITs in a good position despite the overall maturity of the current cycle. There are few red flags about leverage, the quality of properties in REIT portfolios and investment activity, leading respondents to expect share price and total return growth for REITs for the balance of 2019.
Those are the findings of NREI’s fourth annual research survey exploring the state of publicly-traded REITs.
A new favorite emerges
There is a notable swing in terms of what property type respondents favor when it comes to publicly-traded REITs in this year’s survey. Multifamily REITs (47 percent) sit atop respondents’ “buy” lists this year, leapfrogging industrial REITs (46 percent), which was the most favored category in 2018 and 2017. The number for multifamily REITs jumped considerably from 2018’s figure of 36 percent, while industrial’s number fell slightly from 49 percent a year ago. (Respondents were allowed to select more than one type of REIT.)
Medical office REITs (37 percent) ranked third for the third consecutive year. After that, there was a gap before the next REIT types of student housing (22 percent) and net lease (21 percent).
Conversely, retail REITs for the fourth consecutive year were the most frequently named answer on respondents’ “sell” lists. In all, 54 percent of respondents named retail REITs on their lists—just slightly down from 56 percent in both 2018 and 2017. That was also a whopping 26 percentage points above the next most frequently-named sector, office REITs, at 28 percent. (That number was down from 31 percent in 2018). Hospitality REITs (26 percent) came in third on the “sell” list this year.
In answering open-ended questions about challenges and opportunities, however, many respondents pointed to the retail sector in some form. Some pointed out that there might be opportunity in capitalizing on distressed retail assets. Others said that conversion to other uses could generate attractive returns for REITs.
REITs should focus on “repositioning empty retail properties and looking for adaptive reuse of the existing buildings,” one respondent wrote.
Balance sheets check out
Views on REIT balance sheets have remained remarkably stable year after year in our survey. For the third consecutive time, exactly 58 percent of respondents said that REIT balance sheets are “balanced.” There was some movement in overall sentiment. This year, 31 percent said REIT balance sheets are “highly levered.” That is a six-percentage-point jump from 2018 and the highest figure in the four years of the survey. Conversely, only 12 percent of respondents said that REITs have “room to take on more debt,” the lowest figure in the survey’s history.
Respondents continue to have a stable assessment of capital markets for REITs. Roughly two-fifths of respondents said the availability of both equity (39 percent) and debt (40 percent) is unchanged from a year ago. But three in 10 respondents said equity (30 percent) and debt (31 percent) are more widely available. Those figures rose about 10 percentage points from how respondents answered in 2018. Only about one in 10 respondents (13 percent for equity, 12 percent for debt) said capital was less available than a year ago.
In terms of raising capital, for the fourth consecutive year respondents endorsed property-level debt (48 percent in 2019 vs. 50 percent in 2018) as the best avenue for REITs given current market conditions. Another 34 percent endorsed equity issuance (compared with 31 percent in 2018), while only 16 percent said secondary debt issuance was the best avenue (unchanged from 2018).
How to deploy capital
Also consistent with past years is that there is no consensus on what REITs will do when it comes to expanding or shrinking their property portfolios. A plurality (35 percent) said REITs would stand pat. Meanwhile, 28 percent said they would be net buyers and 17 percent said they would be net sellers (26 percent). In addition, one-fifth said they weren’t sure what REITs would do.
Compared to 2018, there was a notable shift in the direction that REITs would be net buyers rather than net sellers. While last year the split was 26 percent saying REITs would sell vs 23 percent saying they would buy, this year the sell number fell to 17 percent and the buy number rose to 28 percent. In all, that’s a net swing of 14 percentage points in the direction of saying REITs would be net acquirers.
In an open-ended question asking what respondents thought were the biggest opportunities for REITs, many wrote in pointing to acquisitions at least in part driven by attractive capital market conditions.
“The biggest opportunity for REITs is the massive amounts of debt available to them at record low rates,” one respondent wrote.
Another added, “Secure long-term fixed-rate debt, cash-in/take profits from non-core assets, acquire strong cash flowing assets, reduce leverage and take advantage of aggressive lenders.”
However, others worried that REITs may have overextended and paid too much for assets that will have trouble delivering the necessary returns.
“Asset values are high and operations have peaked,” one respondent wrote. “There is a lot of junk on the books and those poorly performing assets act as a net drag on their portfolios.”
Other commonly-identified challenges in the open-ended responses were concerns about rising interest rates, general political and economic uncertainty, questions about whether REITs could continue to find quality deals for deploying capital and concerns about overdevelopment in some property sectors and markets.
“The cycle has been so good to the market this time around, it will be tough to convince investors that there is ‘still gas in the tank,’” one respondent added.
On the mergers and acquisitions front, about half of respondents said that now is a good time for mergers (49 percent). That is down from 56 percent of respondents that indicated it was a good time for REITs to pursue tie-ups in 2018. However, more than two-fifths of respondents (41 percent) said they aren’t sure whether now is a good time (up from 33 percent in 2018), while 10 percent said it was a bad time for mergers.
A recent highlight on that front is the pending $5.9 billion all-stock merger of office REITs Cousins Properties Inc. and TIER REIT Inc. On March 25, Atlanta-based Cousins and Dallas-based TIER revealed their proposed combo, which would create an office REIT with a market cap of about $7.8 billion. The newly enlarged Cousins will control a portfolio of more than 21 million sq. ft. of class-A office space.
“While it’s too early to say that floodgates of M&A are suddenly open, this transaction is certainly a signal that the appetite for public-to-public M&A has improved amid the broader REIT rejuvenation of 2019,” Alex Pettee, president and head of ETFs at Rowayton, Conn.-based investment adviser Hoya Capital Real Estate LLC, told NREI in April.
In 2018, there were $76.3 billion in mergers, according to industry group Nareit, one of the busiest years in the sector’s history.
“While 2018 volume was significant due to many REITs being traded at a significant discount to their net asset value, we anticipate 2019 being similar. There are many investors and a great deal of capital waiting for the right time with values, cap rates and so forth,” Greg Ross, national managing partner of the construction, real estate, hospitality and restaurant practice at accounting and consulting firm Grant Thornton LLP, told NREI in February. “The real estate fundamentals are very strong, with low unemployment, low interest rates and high consumer confidence.”
In terms of deploying capital, respondents continue to say that REITs should be paying off debt (51 percent). That’s the same level as last year.
In addition, about half of respondents (48 percent in 2019 vs. 46 percent in 2018) continue to endorse REITs redeveloping or repositioning assets. Just about one-third of respondents in this year’s survey said REITs should acquire assets (34 percent vs. 27 percent in 2018). About one-fourth of respondents said REITs should be investing in core operations (27 percent), while only 13 percent said they should be buying back shares.
In open-ended answers, respondents echoed some of those same points.
REITs should “continue to redevelop their properties and selectively sell existing assets as the redevelopment projects come on line,” one respondent wrote.
Looking ahead
Respondents’ outlook on publicly-traded REIT stock prices is more bullish in this year’s survey than in the three previous years. Overall, 55.1 percent of respondents in this year’s survey said they expect that REIT stock prices will rise for the balance of the year. It’s the first time more than half of respondents have said they expect REIT share prices to rise. In past years, the number came in between 43 percent and 46 percent.
Roughly one-quarter of respondents (23.0 percent) said REIT stock prices will remain flat and just more than one-fifth (22.0 percent) expect them to decrease, down from 31.3 percent in 2018. Overall, however, respondents don’t expect share prices to move much in either direction. The bulk of respondents’ expectations (87.6 percent) are that stock prices will rise or fall by less than 50 basis points.
Respondents had only a slightly less bullish outlook on REIT total returns. Just more than half of respondents (53.2 percent) expect REITs to grow their total returns during the balance of 2019. That’s up from 50.3 percent who had that assessment in 2018 and 47.1 percent in 2017. In addition, 28.0 percent say total returns will be flat for the balance of 2018, while only 18.8 percent said they will decrease (down from 27.2 percent in 2018 and 30.6 percent in 2017.)
As it turned out, REITs ended up posting a total loss of 4.12 percent in 2018, according to Nareit. But REIT performance has been strong to date in 2019. Through the end of April, the FTSE Nareit All Equity REITs index, which includes 169 constituents, was up 16.9 percent year-to-date. Industrial REITs at 26.48 percent have led the way so far, but every REIT sub-sector has posted positive returns.
In that context, there’s some speculation that there could be an uptick in REIT IPOs in 2019, after just five new REITs went public in 2018.
An upturn in IPOs in 2019 could result from public REITs generally trading at the same value as their private counterparts, Cedrik Lachance, director of REIT research at Green Street Advisors Inc., a research and advisory firm in Newport Beach, Calif., told NREI in March.
“I’d say the REIT market is healthy, and the recent increase in share prices might actually bring a little bit more IPO activity and might make the public real estate market an interesting alternative for a lot of currently-private owners of real estate,” he said.
With reporting from John Egan.
Survey methodology: The NREI research report on the REITs was completed via online surveys distributed to readers in May. The survey yielded 555 responses. Just under half of respondents reported their titles as Owner/Partner/President/Chairman/CEO/CFO. The results from the current research were compared against prior studies completed in 2016, 2017 and 2018. The 2016 survey yielded 350 responses, in 2017 it yielded 380 responses and in 2018 it was 350 responses.
