It has been a strong rebound year for publicly-traded REITs and although there is some uncertainty in the air due to the omicron coronavirus variant and the recent elevated pace of inflation, the sector remains poised to continue its strong run in 2022.
In all, Nareit expects further improvement in overall economic conditions, easing inflation and low interest rates to continue to provide a tailwind for commercial real estate. And while there remain questions on some property types—namely hospitality and office—that’s not enough to dim the overall outlook.
Those are some of the conclusions in Nareit’s recently released industry outlook.
WMRE sat down with Nareit Executive Vice President and Economist John Worth to discuss the outlook for 2022 and REITs returns so far year-to-date in 2021.
This transcript has been edited for length, style and clarity.
WMRE: What are the headline takeaways from the outlook Nareit has put together?
John Worth: We are coming on two years of COVID-19 and so we want to ask some of these big questions. As we hopefully—omicron dependent—see the light at the end of the tunnel, the big questions for CRE are what are going to be temporary behavioral changes and what are going to be permanent?
We see that in our own lives, but we also see it in how investors are pricing REIT stocks and in REIT capital markets.
Overall 2021, has been strong year. Year-to-date (through Dec. 8), REIT total returns are up more than 35 percent. That’s an astoundingly good recovery. And even if we start from February 2020 through today, REITs are up well north of 20 percent. In the aggregate, REITs have recovered and that goes to that resiliency story. REITs came into the crisis really prepared. They had delevered balance sheets, access to capital and that combined with fast action from the Fed, and the Treasury Department to make sure capital markets were open and lending markets were open.
That set the pace for the recovery. The key is that the recovery has not been uniform. And that leads us to some of these big questions.
WMRE: What are the biggest unknowns heading into 2022?
John Worth: To me the single biggest question is the return-to-office/work-from-home question. In the outlook, Calvin Schnure makes the very important point that this is less of a question of timing then it is of what happens when people return to office. We see people returning. There has been a steady flow back to the office over the past 18 months. The question for the long-term outlook is whether these new work patterns lead to decline in square footage per worker. So, the question is what the nature of work is over the next few years.
What I think we’re going to see is that need for teamwork, a need to drive innovation and creativity and a need for mentorship, are going to require companies to have an office space setup that is very similar to what they need today. The configuration may change. It may be three days a week. But people will need the majority of their workforces in offices much of the time.
The other key question is retail sales and the role of brick & mortar and e-commerce—both of which are well represented in the REIT space. REITs have a lot of exposure to the digital economy. But brick and mortar is an important part. The point Calvin makes is that as we’ve seen consumers come back to brick and mortar retail, after a burst in the share of shopping online, it hasn’t necessarily been a detriment to online. It’s a “more of both” preference, which could boost both physical retail and digital.
WMRE: There’s also a piece that takes another look at inflation and how REITs perform in inflationary environments.
John Worth: In looking at same-store NOI (net operating income), we find that in general that growth in income exceeds the pace of CPI. Same-store NOI … outpaces annual inflation in 63 percent of quarters measured. That’s true right up to the present in the last couple of quarters. Same-store NOI rise with inflation. The story in stock market returns is underpinned by operating performance. That gets you to the fundamental nature as to why real estate and REITs can provide some inflation protection in a portfolio.
WMRE: On the retail front, it seems part of the story as well is a transformation of what physical retail space is used for. There’s less of a separation between online and in-person retail sales. The two are more integrated. So, it’s not a story of online sales replacing in-person sales.
John Worth: The word of the day in retail is “omnichannel.” You deliver to the consumer in whatever permutation they want. It can be “buy in store.” It can be “buy online, pick up in store,” etc. We are going to look at this period where we made a distinction between online and in-person shopping and view it as a narrow way of evaluating retail.
Retail property owners have taken a lot of lessons out of the COVID experience. Whether it’s curbside pickup, return in person or any of the various ways that you can shop, those are going to be more of the norm. Warby Parker is the stereotypical example of what was a brand that was built on online but found that customer acquisition costs because of the costs of returns and shipping, that to be successful it needed an in-person presence to make the online experience work. There’s no substitute for being there. And that’s going to be true going forward.
WMRE: The last part of the outlook looks at the global picture for REITs. What are the highlights there?
John Worth: One of the features of REITs is that you can invest globally. It gives you another way to diversify. The piece explores some of the differences in the pandemic era across the Americas, Europe and Asia. One of the things that stands out is that in this recovery period, North America has led Asia and Europe because we’ve reopened faster and had a faster recovery in retail and office to a degree. But it’s also because of the large footprint of logistics/cellphone towers/data centers/residential and the role of self-storage. There’s a real lesson of the value of diversifying geographically, but when we see North America outperforming, we have this great advantage of getting exposure that’s much broader than any of the regions of the world.
WMRE: Pivoting to recent results, what are the takeaways from November’s total return numbers?
John Worth: We saw a sell-off at the end of November along with sell-off of the broader stock market and investors were trying to price in further COVID risk from the Omicron variant.
A lot of that was reversed in first trading days of December as investors have become more cautiously optimistic. Office for December is up almost 7 percent. Lodging is up 8.4 percent, healthcare is up 6 percent and the whole REIT market was up 4.8 percent.
This is where geographic diversification is important. Market where you have a substantial amount of consumers who have had three jabs potentially could have very different health outcomes than where the standard is one or two jabs.
WMRE: We also saw some interesting announcements from companies pivoting. Mack-Cali Realty Corp is changing its name and focusing on multifamily. Federal Realty, meanwhile, announced it would focus on life sciences. Any thoughts on this news?
John Worth: One of the things we see in the REIT space is very much that the vast majority of REITs in the U.S. are pure play strategies. They are not diversified strategies. The investor base in the U.S. has traditionally preferred for REITs to have a clear vision about sectors in which they own/operate properties. Veris moving to pure residential focus is inline with what we’ve seen in the last decades. And Federal Realty has been very successful developer of live/work/play environments, but lab space has been one of the great successes of the pandemic.
