With two weeks to go in 2024, the FTSE Nareit All Equity REITs Index is on pace to end the year posting a double-digit rise in total returns. That is roughly in line with the 25-year average of nearly 10%.
Looking ahead to 2025, a confluence of factors, including the outlook for an economic soft landing, lower interest rates, the convergence of public and private real estate valuations and sold real estate fundamentals, provide favorable conditions for REITs to perform well.
Nareit, the association representing the REIT industry, outlined these factors in its 2025 REIT Outlook, published earlier this week.
WealthManagement.com spoke with Ed Pierzak, Nareit senior vice president of research, about recent REIT results and the 2025 outlook.
This interview has been edited for style, length and clarity.
WealthManagement.com: Can you start with the broad picture? What are some of the top takeaways from your outlook for 2025?
Ed Pierzak: Three things come to mind for me. One is the economy and whether or not we can manage a soft landing. Secondly, whether we can close the cap rate gap between public/private valuations. Evidence suggests we are on that path. Lastly, if you can get those two, it opens the door for a revival in the property transaction market.
When we talk about engineering a soft landing, there’s no formal definition of what that is. But if you look at real GDP in the U.S., it came in at 2.8% in the third quarter. You also want a steady unemployment rate. November came in a few days ago and rose slightly from 4.1% to 4.2%. But we also had an increase of 227,000 jobs, and the previous month’s number was revised up as well.
With inflation, the most recent readings showed the CPI at an annualized 2.7% and core at 3.3%. And with the Fed, they’ve put in two cuts and the expectation, if you look at FedWatch, says there’s a 95% probability of a cut on the December meeting.
Lastly, are people worried about a recession? The latest consensus puts the odds down to 23%. You don’t have to look too far back to see when the odds were greater than 60%.
Roll that all up, and we are poised for the Fed to have a soft landing.
WM.com: Why is the macroeconomic situation so important for real estate?
EP: Jobs and the overall economy are the primary drivers of real estate demand. Lower rates benefit the real estate market well.
All that said, we also have to look at the real estate market and have to recognize there is a degree of softness in some sectors.
Looking at the four traditional property types (office, retail, industrial and multifamily), we are seeing a softening in occupancy rates and rent growth rates. Generally speaking, year-over-year rent growth is still positive. So, it’s not a dire situation. But there’s a degree of softness there. If transaction markets pick up, buyers will have to account for all of this in underwriting.
WM.com: Just to underscore, rents are still increasing, just not as quickly as they were at some point. And can you put that in context in terms of whether rents are rising faster or slower than the pace of inflation?
EP: Data in our T-Tracker showed that all of those sectors have higher occupancy rates in the REIT world compared with the broader market. That’s a function not only of operational expertise, but asset selection and how it comes down to picking where and how you manage properties.
If you also look at where investors are placing bets—they tend to be overweight in the modern economy sectors of data centers, telecommunications, healthcare and self-storage. Fundamentals in those sectors are quite a bit stronger and all have good-looking prospects in 2025.
In comparing with inflation, it depends on the sector. Industrial and apartments had a lot of supply come on due to development that was driven by the tremendous rent growth they had been experiencing. Annual rent growth was effectively double digits at the peak. Since then, it’s fallen off. Industrial the year-over-year rate was at 3% in the third quarter, so favorable compared with inflation. Apartments, however, had a big falloff, and rent growth is down to 1% today.
In other sectors, retail never had a big spike and rent growth is still at 2.4% annually. Offices also have maintained positive year-over-year asking rent growth of 1% for nearly three years now. But the key there is that’s asking rent growth. What the effective rents or signed rents are, we don’t know.
WM: Multifamily sticks out a bit given some broader conversations in the country about the shortage of housing. Is what’s happening with multifamily with REITs partly a function of the parts of the market that REITs typically operate in?
EP: It’s supply/demand driven. Very high rent growth triggered a strong supply response. Demand couldn’t keep up and the market is recalibrating. That said, for a lot of investors, apartments have remained of the asset classes that they keen on.
WM: Moving on to valuations, the spread between public and private is something we’ve talked a lot about in recent years. Last month you expressed optimism that the spread was finally about to narrow to a more historically normal range. It sounds like that remains the case.
EP: Strong performance in the third quarter of this year helped cut the cap rate spread in half effectively. When we get to this level of a spread of 50 to 60 basis points, that’s a level on average you will see in non-divergent periods. So, we’re getting to a place where things are back in sync. And I do think we’ll start to see some increased transaction activity.
When markets aren’t aligned, acquisition and disposition activity drop off. But once they are aligned, things accelerate. It’s our view that we will likely see that in 2025. When that does happen, a number of factors benefit REITs. They have not only strong operational performance, but their balance sheets are in order, and their access to cost-effective capital is in order. They will have an opportunity to go into a growth cycle and be more competitive.
WM: Something else you track regularly is capital-raising. In the past couple of years, we’ve talked about how REITs continued to have access to public debt and equity and have been opportunistic about going to the market strategically when the terms have been favorable. But I’m curious, given what you’re saying about the transaction market, if there’s any evidence of REITs perhaps being more aggressive and building up war chests, so to speak.
EP: Through the third quarter, new issuance of equity and debt for REITs already equaled the 2023 full-year totals. So, they have been going to the markets a little more.
One of the things we’ve been highlighting is that raising unsecured debt is a cost-effective way to enter the market. But we also had the Lineage IPO, and we have REITs forming joint ventures with institutions. They’ve gone direct, so to speak, without a middleman.
It says a lot about the operational capabilities to be able to go to some of the largest, most sophisticated investors in the world. Equinix announced a joint venture with GIC and the Canada Pension Plan Investment Board that’s north of $15 billion for data centers. It shows REITs have a lot of options. They can go to the equity market or the debt market or form joint ventures with institutions directly.
WM: Lastly, where do we stand with total returns, both monthly for November and year-to-date for 2024?
EP: REITs were up around 3.5% for both the FTSE Nareit All Equity REITs index and the All REIT index. Drilling down across the sectors, almost all of them were positive. We’ve talked previously about the inverse trading trend of REITs relative to the 10-year Treasury yield. In November, the yield started higher and ended lower and that contributed to stronger REIT performance.
Year-to-date, REIT total returns were at around 14% at the end of November. As we’ve moved into December there’s been some giveback, but total returns are still up around 10%. If you go through history, 10% is about average. So in all, we’ll end up with a year consistent with long-term historical performance.
