Report: Public REITs Up 14% Year-Over-Year, Balance Sheets Strong

In an up-and-down year for commercial real estate, the public real estate investment trust (REIT) sector came out alright. 

A new year-end report by NAREIT, the national Association of Real Estate Investment Trusts, found that public REITs have outperformed private REITs for seven of the last eight quarters, largely due to the strength of their balance sheets, low debt levels and their ability to react more swiftly to changing interest rates. 

Through the end of November, total returns for the FTSE Nareit All Equity REIT Index were 14 percent, significantly above the 25-year average of just under 10 percent, while public REITs outperformed private real estate (measured by the NFI-ODCE index) by 17 percent, largely due to the lag in private real estate pricing in the higher interest rate regime, according to the Nareit report. 

John Worth, executive vice president of research at Nareit, told CO that four megatrends have defined the success of the public REIT sector: specialization (the ability of individual REITs to become world-class operators in one specific line of property), scale (the ability of REITs to grow their operating platforms at a low cost of capital), sustainability (the prevalence of green energy technology among REIT ownership models, especially in Europe), and innovation (the rise of new, niche asset classes like data centers, telecommunications towers and self-storage).  

“These megatrends come out of what we’ve seen as the driving factors over the last 10 to 20 years in U.S. REITs, and listed REITs globally, with an eye toward what will be important in the next 10 years,” said Worth. “Of the four characteristics, the ‘three S’ and ‘I,’ the U.S. is leading the world, and our expectation is the U.S. will continue to move ahead and we’ll also see Europe and Asia adopt those practices.” 

One of the reasons public REITs have benefited from increased investor confidence is the strong occupancy metrics for the big four asset classes. CoStar occupancy rates for the third quarter 2024 found that retail occupancy stood at 95.9 percent, industrial at 93.4 percent, multifamily at 92.1 percent, and Class A office at 86.1 percent. 

While these occupancy rates are encouraging, Worth pointed out that office, multifamily and industrial have all declined from their pre-2020 highs, with the latter two being victims of “historically high rent growth” that has driven “a tremendous amount of supply into those sectors,” thus pressuring occupancy.

“Certainly office, apartment and industrial are in a range you’d say is healthy, but where you have some concern there is the fact that they’ve been softening a bit,” said Worth. “However, office stands alone as being this area, where we’re still trying to come to a conclusion of the long-term process of grappling with work from home. Office is still in the middle innings of this evolution.”

Worth also pointed to the ability of public REITs’ values to more accurately reflect higher interest rates across the economy, rather than trail the upticks by months, if not years, as happens with private real estate valuations.  

In one of the most important pieces of data, Nareit tracked the total return differences between private real estate and public REITs since the first quarter of 2022, when the Federal Reserve began hiking interest rates. 

In the first three quarters of 2022, shortly after the interest rate hike went into effect in February 2022, public REIT real estate valuation were 14.5 percent less on average than private values, a phenomenon that Worth ascribed to private real estate valuations taking “a much longer time to reflect higher interest rates.” 

But since the fourth quarter of 2022, public REIT valuations have exceeded private real estate values on the same types of properties for seven of the last eight quarters, with public REIT values exceeding private real estate values by nearly 23 percent in the fourth quarter of 2023 and by 16.5 percent in the third quarter of 2024.

“It appeared REITs reflected higher interest rates in valuation and private real estate didn’t reflect that until 2023 and 2024 … and really, since that period, it’s been a process of those markets coming back together,” said Worth. “That process has primarily had REITs outperforming private real estate, both because REIT performance has been positive, and because private real estate has started to price in those higher interest rates into their evaluations. So we’ve seen this convergence.”

Moreover, because public REIT values have gone up, and private real estate values have remained essentially flat, the average cap rate spread among all the asset classes has compressed from a differential of 212 basis points in the third quarter of 2023 to 69 basis points in the third quarter of 2024. 

Public REIT debt levels are another cause for optimism. 

The Nareit report showed that in recent years public REITs have maintained low leverage levels while raising capital through unsecured debt offerings — for example,  corporate bonds — and by taking out fixed-rate loans with longer-term maturities. Public REITs’ ratio of debt to asset values stood at less than 31 percent, with the average interest rates on total public REIT debt at 4.1 percent and an average term to maturity of 6.5 years.  

“We think REIT balance sheets are a real source of strength, and that REITs have been able to perform through a period of high interest rates due to [this],” said Worth. “Their well maintained balance sheets will help them as acquirers of properties  -— they have ready-access to new capital through equity issuance and by going out into the unsecured debt market.” 

Finally, Worth pointed to the strength of investment returns in specific sectors across the FTSE Nareit All Equity REIT Index. Year-to-date, health care REITs were up 31.8 percent, while data center returns were up 31.4 percent, retail were up 17.8 percent, and residential were up 14.2 percent, with the overall public REIT index correlated at a total increase of 8.7 percent, year-to-date.

Worth explained that if someone had $100 invested in the FTSE NAREIT health care sector as of Jan. 1, that investor would have $131.80 in total return through a combination of returns through the stock price increase as well as dividend payouts. 

“What they’re recognizing is that to have portfolios that don’t reflect the broad range of commercial real estate is to be out of step with the market economy,” said Worth. “We’re seeing they want to change their portions to have more data centers, more cellphone towers and more health care.”

Brian Pascus can be reached at bpascus@commercialobserver.com