Inflation, geopolitical turmoil and rising interest rates had investors worried in the stock market and REITs were not immune to the sell-off.
Total returns for the FTSE Nareit All Equity REITs index fell 3.66 percent in April, and at the end of the month fell 8.72 percent. While this is a big reversal from 2021, when REITs reported a 40 percent increase in total returns, the news isn’t all bad. In fact, total REIT returns in 2022 outperformed other indices, including the S&P 500 (down 12.92%), the Russell 2000 (down 16.69%), the Nasdaq Composite (down 21.00%), and the Dow Jones Industrial (down 8.73%.).
Among individual property types, while most sectors recorded declines, total residential/resort property yields rose 2.04 percent for the month and rose 9.07 year to date as leisure and business travel continued to recover.
WMRE I sat down with Narritt Executive Vice President and Economist John Worth to discuss the return numbers for April.
This interview has been modified for style, length and clarity.
WMRE: What are the high-level takeaways from the results of April?
John Worth: REITs, along with other stocks, have had a tough month. But REITs outperformed the broader stock market in April. And for most of April — when you go and look at the daily returns — REITs have been resilient. They have been in positive territory coming into April 29th. Then there was a major market shift in sentiment – response to earnings reports, consumer demand and other factors. Therefore, we eventually saw REITs decline during the month, but outperformed the broader stock market.
We are in a period of fear of rising interest rates. As we’ve talked about before, REITs have done a lot to position themselves in a flexible position. There are also a lot of concerns about inflation. But, again, REITs have historically done well in periods of inflation. There are also concerns about continued economic growth. But we have two good signs in this regard. The monthly jobs report exceeded expectations. And while the overall level of employment is still 1.2 million jobs lower than before COVID, we have seen over 20 million jobs created since April 2020.
This gives a lot of confidence that in the near term we will see rapid economic growth, and what we saw in the GDP report is not a harbinger of a recession in the near term. When we look at the year 2023 or 2024, the crystal ball becomes even more mysterious. But indicators today still point to near-term strength in the economy, which flows into rents, occupancy and the overall performance of REITs.
WMRE: Was there anything noticeable on the property level in terms of different performance?
John Worth: Accommodation/resorts showed strong results, up 2 percent for the month and now 9 percent for the year. It is a continuous revival of housing space. We see people outside and around. We’re seeing some recovery for business travel. We see REITs working through recruitment challenges. In a JOLTS (Job Opportunity and Employment Turnover Survey) report released earlier this week, it was stated that there are 1.9 jobs available for every unemployed person in America. So this really turns into the service sector.
WMRE: What about the other party? What are the real estate sectors that experienced difficult months?
John Worth: Total office revenue decreased 10.5 percent. It was a turnaround in what had been a good year for the position overall. I find that the April numbers are not necessarily in line with what we’re seeing in terms of fundamentals. We hear more companies are making returning to the office a priority. And one of the things we’ve been looking for in the JOLTs report is whether there are high rates of smoking cessation in some of the sectors that use the office. But we haven’t seen any meaningful evidence of that. So overall, the total office revenue numbers seem a bit contradictory to what we’re seeing in terms of continued movement in this segment.
WMRE: This is surprising. From everything we’ve seen, the fundamentals of commercial real estate are pretty solid across the board, even when you factor in some of the questions in the office sector.
John Worth: We’ve seen office vacancy rates higher than they were before COVID, but they’ve leveled off. We didn’t see an additional rise in the first quarter. We also saw positive rental growth in the space. One of the things that has helped support the office segment is that while we’re not seeing a lot of net absorption, we’re also not seeing a lot of new supply in the market. So, this helps provide some stability.
WMRE: We recently did an annual industry survey and found some of the highest levels of optimism we’ve seen in the years we’ve done this, even on top of the solid performance the sector is already enjoying. First half results 2022 WMREThe poll of Marcus and Millisap was very positive.
John Worth: This is one of those instances where April has to be categorized in terms of what happened on the first 28 days of the month and then what happened on the 29th. Total returns on industrial REITs fell more than 7 percent on April 29 after rising nearly 5 percent during the first four weeks of the month. So they were having a good month, but were really derailed by Amazon earnings and some statements about increasing their fortunes in their industry portfolio. But what we see more broadly is that industrial rent growth is still very strong. CoStar reports industrial REITs increasing more than 10 percent year over year. There is a constant demand for industrial space even though we are seeing a huge amount of new supply coming online. Net absorption continues to exceed new supply each quarter.
WMRE: So it seems like a lot of what’s happening really stems from overall concerns rather than specific issues within real estate.
John Worth: Much of what is happening in the market is concerns about interest rates, inflation, and what the Fed’s policy for economic growth means. Our Quarterly T-Tracker Program Comes Live [later this week] Preliminary results showed that REIT fundamentals were very strong in the first quarter. It looks like FFO will be at an all-time high. FFO totals $18 billion — more than 30 percent more than last year and 10 percent from the pre-pandemic high. The operational performance of REITs remains very strong, underlining the strong fundamental fundamentals.
As we move into a higher interest rate environment, it’s important to keep in mind that REITs have done a lot over the past decade in addition to making themselves more resilient and we’re seeing that paying off. They have reduced their influence over time. The debt to total assets ratio on the bases of books and markets remains at an all-time low. And the total interest rate expenditures on REITs are at their lowest point ever. In addition, REITs were able to terminate their debts. Today, the estimated weighted average term to maturity of REIT debt is approximately 90 months.
All of this means that REITs can be strategic about when to issue new debt. In April there was very little debt issuance. And debt issuance to date is slightly less than in the first four months or 2021. The strength of the balance sheet allows them to exercise some discretion.