REIT share prices have taken a beating over the past 18 months, while the commercial real estate industry at large is grappling with higher interest rates and declining valuations. So, it’s understandable that many investors may be reluctant to run out and start buying REIT shares. But recent insights from global investment management firm Cohen & Steers indicate that today may, in fact, be an opportune time to invest in traded REITs as they may be among the first beneficiaries as the real estate cycle moves from recession to recovery.
For example, the firm has counted five recent examples of publicly-traded REITs making major investments in private assets—with four of those deals involving properties owned by Blackstone REIT (BREIT) and one by private funds associated with Blackstone. BREIT, along with several other non-traded REITs, has faced redemption requests from shareholders exceeding their monthly and quarterly caps, which might have created pressure to generate additional cash through disposition of assets.
The deals by public REITs included Realty Income Corp. investing $950 million in common and preferred equity interests in the Bellagio hotel and casino in Las Vegas, owned by BREIT; Public Storage buying Simply Self Storage and its 9-million-sq.-ft. portfolio from BREIT for $2.2 billion; Prologis Inc. paying $1.3 billion to acquire a 14-million-sq.-ft. industrial portfolio from opportunistic real estate funds associated with Blackstone; and Ryman Hospitality Inc. buying JW Marriott San Antonio Hill Country Resort & Spa in San Antonio, Texas, from BREIT for $800 million. In addition, back in January, VICI Properties Inc. purchased a 49.9% interest in MGM Grand and Mandalay Bay Resort properties in Las Vegas from BREIT for approximately $1.27 billion in cash and assumption of existing property-level debt.
In Cohen & Steers’ view, these transactions testify both to the strength of traded REITs’ balance sheets and their continued access to alternative sources of capital, such as unsecured bonds, at a time of tightened liquidity and the opportunities the REITs will have to expand their portfolios with attractive assets at affordable prices over the coming months.
The Nareit All Equity REIT index has posted positive total returns year-to-date in 2023 after a steep decline in 2022. Nareit has also chronicled the spread between public and private markets, and although that gap has narrowed in 2023, there is still room for convergence.
REIT balance sheets are also in relatively healthy shape.
“Leverage ratios, at 34%, are still low,” Edward F. Pierzak, Nareit senior vice president of research, told WMRE earlier this year. “And the type of debt they have is predominantly fixed-rate debt with an average weighted term to maturity of about seven years. The weighted average cost of capital is now at 3.7%. So, on one hand, REITs are not immune to uptick in rates. But over that same period, the cost of capital started at 3.3% and ended at 3.7%. Meanwhile, you have the 10-year Treasury at 4.0%. It’s attractive debt and they are well-positioned to handle what 2023 has to hand out.”
Last year, as the commercial real estate market entered a period of greater uncertainty, publicly-traded REITs were net sellers of properties, notes a paper published by Cohen & Steers this Monday. But that trend seems to be changing as they begin to pick up new assets. And historical research shows that over the 12 months when a real estate cycle begins to move from trough to recovery, traded REITs’ returns tend to reach slightly above the 20% mark. That compares to returns of 13.1% for all U.S. equities and 9.2% for U.S. private real estate during the same cycle phase. In fact, the returns for traded REITs in the phase between trough and early recovery tend to be higher than returns for U.S. equities or private real estate during any part of the cycle.
To discuss these conclusions, we spoke with Rich Hill, head of real estate strategy and research with Cohen & Steers.
This Q&A has been edited for length, style and clarity.
WMRE: We’ve heard from multiple experts in recent months that valuations in the private markets continue to lag the public markets in pricing in new risks associated with the current environment. It sounds like you agree with their assessment?
Rich Hill: Yeah. We do. Sort of as an opening I want to note that we have a core thesis that listed real estate is a leading indicator for private real estate. And that helps to inform our view that private valuations will probably be down 20% to 25% peak to trough. Right now, they are down only about 10% to 15%. And so, what we think is maybe most interesting and isn’t getting enough attention is that listed REITs already bottomed out in our opinion. Listed REITs have risen in three consecutive quarters now. On the other hand, private is still correcting.
WMRE: How much longer do you think it will take for the private market to fully price in the changed environment? Some market observers estimate that for public and private valuations to converge it normally takes about 10 quarters. Do you agree with that?
Rich Hill: Historically, I would argue it takes about 18 to 24 months. But we believe this cycle it will play out faster than we’ve previously seen. What’s driving the valuation reset this time around is much different than what was driving it post Savings & Loan crisis and post the Great Financial Crisis. Commercial real estate fundamentals are actually on pretty solid footing. What is driving the valuation reset this time around is the significant rise in financing costs at a time when lending conditions are tightening. So, there’s not much to debate there. What’s actually quite different about this cycle is that appraisal valuations are leading valuations much lower, not transaction valuations. Appraisers are pushing valuations much lower, quickly, because cap rates are higher [and discount rates are higher] given the rise in Treasury rates.
WMRE: Can you talk about some of the recent deals with traded REITs buying private assets? What do those transactions tell you about where market dynamics are headed?
Rich Hill: Given that listed REITs are a leading indicator for private markets, listed REITS tend to sell assets before property valuations fall and they tend to start buying assets early in the cycle. Listed REITs were actually selling assets in 2022 and private [players] were buying assets in 2022. So, there is an amount of discipline that is placed on listed REITs from the public markets. We think as the commercial real estate market starts to move from recession to early cycle you are going to see listed REITs become buyers of assets.
WMRE: There is some debate about that, but it sounds like in your view the commercial real estate market is in a recession right now and we are at the bottom of the cycle?
Rich Hill: I think it’s very clear that U.S. commercial real estate is in a recession right now. So, it begs the question of why are listed REITs in a relative position of strength? First and foremost, their balance sheets are quite strong. I only bring that up because there is a lot of focus on banks pulling back on commercial real estate lending and listed REITs don’t face anywhere near the same headwinds as the rest of the market [in that respect]. Second point is that they actually have access to diversified sources of capital. For example, they can access the senior unsecured bond market and they have been active issuers of senior unsecured bonds throughout 2023. And their fundamentals are actually pretty strong. They’ve done a very good job of de-risking their portfolios over the last five to seven years. So, we think they will begin to acquire assets as valuations begin to decline.
WMRE: Was there anything that struck you about those recent REIT acquisitions? What did you think about the pricing on those transactions?
Rich Hill: We’ve written in the report we published today that we think the valuations are fair. By no means are listed REITs getting these assets for cheap. I want to be clear about that. They are not getting something for a bargain here. We think the bigger point though is that it demonstrates that listed REITs are in a relative position of strength, which will allow them to go on the offensive over the next several quarters or several years as valuations are repricing lower.
WMRE: Do you expect the trend of traded REITs picking up private assets to intensify in coming months? To what extent?
Rich Hill: I don’t want to put an exact number on how much they will be buying. But we do anticipate that they will move from net sellers to net acquirers over the next 12, 18, 24 months. And we would encourage listed REITs to become acquirers if they see value. We would encourage them if they see opportunities, both in the private market and through M&A, to strengthen their portfolio of assets in creative ways.
WMRE: What does this mean for investors and financial advisors who want to capitalize on that trend?
Rich Hill: What I would start with is—let’s be transparent on where listed REITs are trading on an implied cap rate basis—as of today, they are trading at a high 5% implied cap rate. And that's 150-basis-point spread compared to two years ago. They already repriced. They are at the level where the private market is already heading. But that’s not to suggest that we only see value in listed REITs. We also see opportunities in the private market. We think capital is being raised by various different types of new funds, and investors that have the capital will be in a position to take advantage of opportunities that [will be available]. And frankly those opportunities don’t come along that often.
WMRE: Are there certain types of investment vehicles, ETFs, mutual funds etc., that would be better for this than others when investors try to figure out how to best take advantage of this?
Rich Hill: I wouldn’t want to discuss any specific single name REITs. What I would tell you—if you look at NCREIF funds, or even look at non-traded REITs, they own significant portions of industrial and multifamily properties. What REITs provide are advantages. They offer diversified exposure to the commercial real estate market. In many respects, people think of the commercial real estate market as offering the four main food groups: office, industrial, retail and multifamily. But there are things like data centers, for example, that we are very bullish on. We also like things like seniors housing, which are hard to get into through the private market. So, I think what I would tell you is that we think it makes a lot of sense to add listed REITs to a portfolio of private real estate.
WMRE: So, it sounds like you are a pretty agnostic on which vehicles to use to invest in listed REITs?
Rich Hill: We are actually very agnostic. We are very much valuation focused. I do think there will be a time when private core real estate vehicles will offer very attractive returns. I think there is a lot of focus right now on debt opportunities and opportunistic opportunities.
WMRE: Are there any challenges for listed REITs in today’s environment that still exist that investors should be aware of?
Rich Hill: I think the biggest challenge is they are inherently more volatile over the near term. So, there’s some apprehension of when you are supposed to invest in listed real estate. It feels uncomfortable to invest in listed REITs in a recession. But historically, the best entry points for listed REITs have been during early cycle recoveries. And the very best returns come when you transition between a recession and early cycle, when REITs have historically delivered next 12-month returns of more than 20%.
