REIT Earnings Show Strong Growth Amid Market Volatility
Public REITs posted strong operational performance during the second quarter, including 12.4% year-over-year funds from operations growth, 6.8% NOI growth and same-store NOI up 4.1%.
Meanwhile, in August, the FTSE Nareit All Equity REITs Index fell 2.7%, although for the year, REITs have slightly outpaced the broader equity market. The year-to-date total return for FTSE Nareit All Equity REITs through Aug. 31 was 14.5%, while the Dow Jones U.S. Total Stock Market was up 13.5% and the Russell 1000 was up 13.0%.
Wealth Management spoke with Ed Pierzak, senior vice president of research at Nareit and John Worth, executive vice president for research and investor outreach, about the quarterly earnings season and the year-to-date results.
This interview has been edited for clarity and length.
Wealth Management: What are some of the takeaways coming out of earnings season?
Ed Pierzak: REITs have continued to outperform the broad equity market. Both measures are at about 13%. The outperformance has been sizable.
One of the things we talked about in one of the commentaries is that we find strong equity performance has been underpinned by strong operational performance. FFO growth has been in the double digits. NOI growth is over 6%. And same-store NOI growth has been roughly 4%.
Every metric is keeping pace with inflation. Operations are quite solid. Over 70% of REITs posted positive FFO growth, and nearly 80% posted positive NOI growth. So we’re looking at solid numbers across the board.
Another element I like to point out is the occupancy rate data from the last few quarters. Office stands out, increasing 3 percentage points to 88%. It’s a positive sign.
One of the big things we’ve noticed prior to putting out these commentaries is that, when you look across CoStar data for sectors with momentum and solid movement, office stands out. As much as we’ve heard about office’s struggles, we’re seeing a bit of a resurgence. According to our active manager tracker, office is the only traditional property sector with an overweight position (relative to the composition of the FTSE Nareit All Equity Index).
WM: One point you’ve made in the past is that REITs also tend to own higher-quality properties. So is there a delta between occupancy rates for office REITs and for the broader market?
EP: The office occupancy rate, according to CoStar, was 86.1%. According to NCREIF, it was 81%. So, if that gives any sort of flavor, you are talking about a delta of 7 percentage points.
In general, although REITs tend to be net acquirers, they are always pruning portfolios, too. Perhaps an asset has fulfilled its objective or is underperforming. REITs are willing to sell, move and get money into something that may work better.
John Worth: An interesting example is the Washington, D.C., office market. Overall, the market is not great, but there is huge demand for high-quality, well-amenetized, brand-new properties. One REIT, BXP, has two very large office development projects in D.C., and they have lined up anchor tenants and are building with move-in-ready tenants. The ability to use their balance sheet to get these development deals done has also been a real differentiator. They are expanding a high-quality portfolio by undertaking development projects in a market starved for high-quality office space.
WM: What about REIT balance sheets overall?
EP: We’ve been beating the same drum for a while. The leverage ratio remains low, at 34%. And of the debt REITs are carrying, 90% is fixed-rate, and 83% is unsecured, so it’s at the corporate level rather than the property level. The average term to maturity is almost six years.
Overall, REITs’ cost of debt is around 4.2%. When you take into account that the 10-year Treasury was 4.4% at the end of the second quarter, REITs have been able to keep control of all-in debt costs.
WM: That seems very positive, especially amid some of the macro signals we’re getting, such as rising rates on long-term debt.
EP: Looking at things like FedWatch, everyone largely expects the Fed to maintain the target rate, but just under 40% now expect an increase. So we’ve had an elevated interest rate environment, and there’s an expectation that they may tick up again.
For REITs, having a strong balance sheet and access to a variety of capital sources places them in a great position as they look to property or corporate needs, but also for funding growth.
WM: Any other observations from the quarter end?
EP: There remains the theme of divergence. The implied average cap rate for REITs was at 5.74%, and the private real estate appraisal cap rate remains at 4.47%. We still have this gap. Private real estate appraisals have effectively hit a ceiling and won’t move. They are priced as if we’re in 2021, from a REIT cap rate perspective. Meanwhile, at the end of the quarter, the 10-year was 4.42%, so the appraisal cap rate was just 5 basis points over the 10-year Treasury.
At some point, there has to be a reality check. But private markets are really taking their time. There was a point when it seemed the market might return to the appraised levels, but now things may be going in the other direction.
WM: Are there any other recent pieces of research to highlight?
JW: We have a case study about Resolution Capital, a Sydney-based active manager working with clients around the world. They worked with an European institutional investor that had a private real estate portfolio that primarily focused on its home market.
Resolution Capital built a portfolio that was able to get the investor a dramatic increase in both property sector diversification and geographic diversification with a new REIT portfolio that covered the rest of Europe, the United Kingdom, New Zealand, Japan, Canada, Hong Kong and a large exposure to U.S. real estate.
It’s another example of how institutional investors can use REITs, in this case, with an actively-managed portfolio designed to address the limitations of a private-only model. It’s another example of not just the “why”, but the “how” in ways institutions are using REITs.
WM: Lastly, I wanted to ask about data centers. It’s been a hot area for a while, but now there’s also this blowback that, in some ways, seems like it’s blowback against AI. It also seems to elide that not all data centers do the same thing. Most data centers are not what the hyperscalers are using, etc. How has Nareit been trying to address that?
JW: We are communicating with lawmakers to convey how data centers support our daily activities. The data centers in REIT portfolios are more likely to be supporting everyday activities, such as online shopping, social media and 911 operations, rather than being used for standalone hyperscaler model training.
This comes up with investors as well. The REIT data center model has very much focused on having customers in place. REITs own about 600 data centers globally, and they are all full. They have built-in rental income from cloud-based services, with AI-driven increases in demand coming on top of that.
That creates a different risk profile. REIT data centers are used for inference rather than training. They are not hyperscaler facilities and not in the middle of nowhere. They are also a way the vast majority of Americans can be owners of data centers and not just users. That’s all part of our message to make sure policymakers understand.
