according to new research According to the Nareit Association, which represents publicly traded real estate companies, 168 million Americans, or about 50% of U.S. households, have some investment in public REITs. This ownership can be direct stock ownership or through mutual funds, ETFs or target-date funds including real estate investment trusts.
Nareit arrived at this figure by analyzing the Consumer Finance Survey released by the Federal Reserve. Nareit said, “The proportion of households directly holding stocks increased from 15.2% in 2019 to 21.0% in 2022. Most households’ equity investments are made through tax-deferred retirement accounts, which increased from 15.2% in 2019 to 21.0% in 2022. 50.5% to 54.3% in 2022. “
Other recent analysis by Nareit looks at The State of REIT Balance Sheets and provided updates on Valuation Gap Between Private Real Estate and Public REITs.
Wealth Management Network Discussed these reports and January’s results with Edward F. Pierzak, senior vice president of research at Nareit.
Wealth Management Network: Let’s start with the findings on U.S. households’ exposure to public REITs. I’ve been thinking about this a lot lately, given how many mutual funds and ETFs contain REITs and retirement plans. What do you think of this number?
Ed Pilzak: Our equity holdings have increased significantly. If you go to 2019, the number was 15%, and by 2022, the number will be 21%. This is a way to increase your exposure. The most significant benefit of owning REITs are target-date funds. This suggests that the typical American is increasingly exposed to commercial real estate, and they do so through traditional 401Ks, mutual funds and target-date funds, which are growing in popularity.
WM: You recently wrote an article updating the balance sheet position of REITs. We’ve talked about this in the past, REITs are generally in a strong position when it comes to interest rates, fixed versus floating rates, and long duration. Are you still insisting?
EP: If we look at the broader picture and the performance we saw in January, that’s an extension of that. January’s numbers were disappointing, with REIT total returns slightly negative, a loss of less than 5%. The Russell 1000 index edged up about 1%. Performance was consistently negative across sectors, with the exception of data centers, which grew 3.5%. That’s not surprising, considering all the rides they’ve taken in discussions of artificial intelligence. We are seeing a number of active REIT investment managers adding positions in this space.
If we take a longer view, REITs were still up 16.2% from mid-October to the end of January. That’s a solid gain compared with the Russell 1000’s 14% gain.
So, you can look at all this and say, “What happened in January?” At the beginning of this year, economists and financial markets expected the Federal Reserve to make a series of interest rate cuts in 2024. Now, we’re getting some signs that the rate cut may be delayed. Chairman Powell actually said he was playing down the possibility of a rate cut in March. Then we got the report that 350,000 jobs were created in January, which was a surprising upward trend and better than economists predicted.
The reliable news is that the economy is doing well. But this means any policy easing is likely to be delayed. So, our thinking is that while history tells us that a higher interest rate environment does not equate to poor or negative real estate performance, the January REIT numbers are likely to react to that, with real estate trading in the low to mid range. , low market performance is good. High interest rate environment.
This brings us to the latest article, which is that if we don’t see any rate cuts, REITs will be fine. The weighted average cost of debt for REITs remains 4%. It is lower than the current 10-year Treasury note. More than 90% of REIT debt is fixed-rate and nearly 80% is unsecured. This should prove to be a competitive advantage. The outlook for REITs is very good and we think they will outperform private real estate.
WM: This is a great continuation of your other article, which is an update on the differences between public and private real estate valuations. We’ve been discussing the concept of these aggregates for some time. Where are we in this process?
EP: The difference between REIT implied capitalization rates and private real estate capitalization rates remains over 200 basis points. If REIT cap rates dropped all the way to private, property valuations would have to increase by 50%. This is unlikely to happen. But we think there will be convergence through some growth in REIT performance and some writedowns on the private side. Both parties will actively participate in this process.
WM: Just think about the interest rate situation and inflation, one factor here is that a lot of leases are signed with inflation in mind, right? So, isn’t this what makes REITs resilient to the current interest rate environment?
EP: We’ve reported about 30% quarterly earnings to T-Tracker. We’ll have a fuller picture in a month, but when we look at operating performance, we see that REITs’ operating performance has been keeping pace with inflation. However, the strength of the gains has been weakening as inflation has fallen.
This is a complicated story. One thing we mentioned is access to capital. This is one of the positives. It provides REITs with the opportunity to make opportunistic purchases as they surface.
WM: Is there any progress on this? Or are the markets still frozen?
EP: We are still in the price discovery process. It’s working. In many ways, private market participants must recognize this. They will have to raise cap rates further before the trading market returns to balance.
