August brought another setback for publicly-traded REITs' total returns with the FTSE Nareit All Equity REITs index falling 5.9 percent, leaving the index down 17.4 percent year-to-date. The results were in spite of REITs wrapping up a strong second quarter earnings season, in which they posted funds from operations (FFO) of $19.6 billion—up from $17.8 billion in the first quarter and from $16.9 billion in the second quarter of 2021.
REITs continue to be caught up in the broader volatility and uncertainty dragging down equity prices. The 17.4 percent drop in total returns for the All Equity index sits in comparison with a 12.01 percent fall for the Dow Jones Industrial Average, a 16.14 percent drop for the S& 500, a 17.16 percent decline for the Russell 2000 and a 24.07 descent for the Nasdaq Composite.
WMRE caught up with John Worth, Nareit executive vice president for research and investor outreach, to discuss the latest monthy results and how REITs are trending so far in September.
This Q&A has been edited for length, style and clarity.
WMRE: Can you give us the 30,000-ft. view on August results and how REITs are trending in September so far?
John Worth: The August REIT sell-off trended along with the broader stock market. Across the stock market investors are working to price in the prospect of higher interest rates and slower growth toward the end of this year and into next year.
The good news is we have seen a significant rebound so far in September with the index up 2 percent on a month-to-date basis. So, it’s bouncing back quite quickly.
Since we talked last, we also put out the latest T-Tracker and we saw really strong operational performance in Q2. FFO reached a record high of $19.6 billion, which is 9.8 percent increase from Q1. In addition, nearly 84 percent of REITs posted growth on a year-on-year basis. So it’s a continued, widespread recovery.
That doesn’t mean we don’t have risks in the quarters ahead, but what it means [is that] REITs are coming into that period with a basis of strong performance at their backs.
My colleague Edward Pierzak put out an interesting market commentary in terms of where we are in terms of FFO today vs. where we were in 2019, pre-COVID, and in 2020, in the depths of COVID. REITs have FFO today that is more than 22 percent higher than the pre-COVID period. It’s also 50 percent above where we were in 2020. Overall, we’ve got nine of the 11 sectors that report FFO with higher FFO today than pre-COVID.
WMRE: On the property level, does anything stand out from the August numbers? It looks like self-storage was the only sector to eke out positive results. Most of the rest of the sectors appear to be down in the five percent to seven percent range and office REITs lagged that, down more than 10 percent.
John Worth: Self-storage did lead the way and it is one of the stronger performers on a year-to-date basis as well. The weakness of offices stems from being in the middle of this work-from-home transition debate, plus the layering on of the prospect of slower economic growth.
WMRE: There has been some buzz again about Labor Day perhaps being a threshold for a greater return to office. We are only a few days past that, but are there any indications of momentum on that front?
John Worth: We are going to be watching the swipe data from KASTLE and the mobility data. We think all of that will be interesting in the short term.
However, it’s clear that we are in the middle of is a longer-term transition on the office sector. There continues to be a lot of experimentation with how we organize our lives and the workplace and how those two intersect. That is going to take longer than a couple weeks after Labor Day to sort out. We are in the middle of multi-year period of experimentation. So, while the swipe data may show an uptick, it’s important not to get too caught up in that.
WMRE: I see. At one point it seemed like we kept looking to there being some moment that might be a clear inflection point, but now it’s becoming clearer that this is going to remain a process and we shouldn’t expect there to be some clear break?
John Worth: Yes, we have moved to a place where we are beyond that expectation. Employers and employees working [are] out what works over the long term. There are lots of examples of organizations with “core days” where they are bringing most of their employees in. So even if you’re not in five days a week, you have a few days a week where you are bringing people in.
Importantly, what that means from a real estate perspective is it means it doesn’t change your need for office space, because if you cut back you end up with a “peak load” problem. So even without having everyone in five days a week, if you are an organization that is bringing all or most people together reasonably frequently, that effectively doesn’t change your need for space.
Interestingly, I was also in Europe last week at the Europe Public Real Estate Association conference. The European view is one that is dominated very much by getting people back in the office. They are in many ways ahead of us in that process.
WMRE: With the interest rate rises we’ve had so far and the signal of more rate hikes coming, how does that impact REITs?
John Worth: One of things that’s important to understand is that REITs are well-prepared for a period of rising rates. Leverage levels have trended down considerably since the Great Financial Crisis and are near all-time lows. The tenure of that debt is also quite long—on average termed out over seven years. In addition, REIT interest expenses are at all-time lows. So, while a period of high interest rates is never good for real estate, REITs are positioned to weather that effectively.
WMRE: Last time we talked, we also touched on the fact that real estate investment sales volume is dropping, particularly the more highly-levered buyers need to step back. But REITs, as well as other buyers less reliant on debt, might be able to step in to do deals. What have you seen happening with transactions?
John Worth: REIT acquisition volume for the quarter is about $18 billion. While that’s down from Q4 of 2021 and Q1 of this year, if you go back historically, that’s pretty healthy for transactions. While we’ve seen CRE transactions fall dramatically on an industry-wide basis, REITs have certainly exceeded expectations in terms of what they’ve been able to execute. Higher leverage buyers have had to step out of the market. REITS with large operational platforms and large acquisition platforms have been able to step into those transactions and keep volumes higher.
WMRE: On the investor side, have you seen any movement in portfolio allocations and attitudes towards REITs, given current market conditions?
John Worth: In the generalist world I haven’t seen a sharp selloffs in REITs in particular. The investor space where we’ve been talking to investors the most is in the institutional space—the longer-term investors. What’s quite interesting is when you look down that list of top property types, what institutions want to add, those are all sectors where there’s a very meaningful access to those sectors through REITs. That’s mapped with conversations we’ve been having with investors in terms of using REITS for a portfolio completion strategy. Institutions understanding their current core portfolio needs to be mapped to the modern economy.
