‘The COVID Discount Bin’: Investors Lose Confidence In CRE As REIT Stocks Slump
While major stock indices show the market has largely recovered from its coronavirus-induced plunge, REIT stocks are still well below their pre-crisis levels, showing a lack of investor confidence in the future of commercial real estate.
The Nareit index of all equity REITs was down 16.38% year-to-date as of Monday's market close. The REIT sector is far underperforming the broader stock market, with the S&P 500 closing Monday up 0.78% on the year.
"It's a little bit puzzling because, in terms of operating performance, most sectors of commercial real estate have not been really hard-hit," said Calvin Schnure, Nareit senior vice president of research and economic analysis. "What I suspect is going on is investors are concerned there may be longer-term structural changes in real estate markets."
Stock performance within the REIT sector has varied widely by the segment of the real estate industry the companies represent. Hotel, retail, office and apartment REITs have experienced the worst year-to-date performance, while data center, industrial and infrastructure REITs are up on the year.
While the hotel, retail and office sectors have suffered worse losses, experts have been most surprised by the underperformance of the apartment market.
The apartment REIT segment was down 25% year-to-date as of Friday, according to Nareit.
"I certainly would have expected apartment REITs to be performing better," Schnure said. "There's concern about whether tenants will be able to make rent payments, but even if you look at broad measures ... you find a large majority of tenants continue to make rent payments on time even after extended unemployment benefits expired."
The National Multifamily Housing Council's Rent Payment Tracker found Sept. 6 that 76.4% of U.S. apartment households had made a full or partial rent payment for this month, the lowest level since the beginning of the pandemic.
With rent collections gradually declining, some of the largest apartment REITs have been slow to recover from their low levels. Equity Residential was down 34.7% year-to-date as of Monday's market close, Essex Property Trust was down 31.5%, and AvalonBay Communities was down 29.6%.
Schnure said he thinks investors are overly concerned about apartment REITs, especially because these companies tend to own higher-end properties with more financially stable tenants.
"REITs own a different slice of the apartment market than broad private investors," Schnure said. "Many of these are luxury apartments, and a lot of the tenants in a REIT-owned apartment complex are financially secure. These are the people who can work from home."
Green Street Managing Director and Head of U.S. REIT Research Michael Knott also thinks the market is overreacting to the downside of apartment REITs. According to Green Street, total returns in the apartment segment were down 29.4% from the market's Feb. 21 high as of Wednesday.
"Apartments should eventually bounce back after a rough patch here fundamentals-wise in the next year or so," Knott wrote in an email. "But there should not be a permanent headwind the way hotels may see and how brick and mortar retail will continue to see ... at these levels, apartments are in the Covid discount bin."
The sharp drop in tourism and corporate travel caused by the pandemic has taken its toll on lodging REITs, especially ones that own large downtown hotels.
The lodging REIT segment was down 47% year-to-date as of Friday, according to Nareit. This underperformance has been less surprising to experts than apartments, as hotel occupancies have continued to average below 40%.
"It's ugly," said Robert W. Baird Senior Research Analyst Michael Bellisario, who covers hotel REITs. "In a way, it's the perfect storm to the downside for REITs specifically, in that not only are hotels and travel broadly impacted, but REITs own higher-end hotels that are dependent on group demand in the top five markets."
Within the hotel REIT sector, the best-performing companies have been ones that own select-service hotels in smaller markets that people tend to reach by car.
A company with this type of portfolio is Apple Hospitality REIT, which started the year at $16/share before dropping below $5 in March. It then rebounded above $13 in June, but it closed Tuesday at $9.38, still down more than 40% on the year. Bellisario named it as his top pick for hospitality REIT stocks.
The companies that have performed the worst are the ones with portfolios of large hotels in major cities that depend on conferences for demand. These REITs include Park Hotels & Resorts and Ryman Hospitality Properties, which are down 61% and 58% year-to-date, respectively.
While hotel demand has been slow to recover, lodging REITs have improved from their March lows because the companies have largely shored up their balance sheets and investors no longer see much risk of corporate-level bankruptcies, Bellisario said.
"The worst case is what people feared in March and April: 'Are these companies going to survive or are they going to go bankrupt?'" Bellisario said. "Conversations with investors now are less about liquidity and downside risk and survival, and more on how to position for the upside, what markets are going to be better and when does a vaccine come."
The office REIT segment has also been hit hard by the pandemic, but more because of long-term concerns over demand than short-term operating issues.
Office REIT stocks had decreased 28.8% year-to-date as of Friday, according to Nareit.
Total office REIT returns have decreased 35.3% from the market's Feb. 21 peak, according to Green Street. Knott said he thought office REITs were overpriced before this year, and the pandemic has increased concerns that companies could reduce their footprints as more people work from home.
"We still find office to be expensive in the public market, but it entered Covid as being pricey in our view, so even though it has underperformed in the recovery, it is likely to still be challenged by [work-from-home] trends," Knott wrote in an email. "We’ve long been skittish on the [capital expenditure] profile of office, along with low cap rates and so-so growth.”
Schnure said he thinks the concerns about remote work are exaggerated, and he expects to see a countervailing trend of companies increasing their square-footage-per-person as they move away from densely packed office environments. But he said there are risks related to geographic shifts that could hurt REITs with downtown-heavy portfolios.
"I think the demand for office space is still going to be there," Schnure said. "One downside risk is that the work-from-home does free things up so people that might have needed to be in a Central Business District office may move out to suburban office parks or shift to secondary cities, places where the rent is cheaper."
REITs with New York City office portfolios have been particularly hard-hit amid fears about the future of the country's densest city. Empire State Realty Trust's stock closed Monday down 56% on the year — it hit a record low price this month — Vornado Realty Trust was down 49.1% and SL Green Realty was down 47.5%.
Business closings and shifts in consumer behavior have created a difficult year for the retail REIT segment.
The full retail REIT segment was down 36.3% year-to-date as of Friday, according to Nareit. It also broke it down by product type, with regional mall REITs down 50.4%, shopping center REITs down 40.1% and free-standing retail REITs down 17.6%.
Mall REITs have been hit hard by retail bankruptcies caused by the shift to e-commerce. But Macerich CEO Thomas O'Hern told investors last month that many of the retailers that have gone bankrupt this year were already on the company's watchlist before the pandemic, and he thinks retail will continue to be a valuable asset class going forward.
"Even with growing and accelerating e-commerce, sales cannot make up for the lost sales and profits from the physical stores," O'Hern said on the REIT's Q2 earnings call, according to a Motley Fool transcript. "The crisis has emphasized the importance of brick-and-mortar locations as key sales and profit drivers for most retailers."
According to Green Street, total returns for mall REITs are down 46.5% from the market's Feb. 21 high, while strip center REITs are down 34.4%. Knott said he thinks the performance of retail REITs is "roughly appropriate."
The Winners: Data Center, Industrial and Infrastructure REITs
The shift to online platforms has benefited some commercial real estate sectors, such as data centers, warehouses and telecommunications infrastructure, and the companies that own those properties have experienced strong stock performance.
Demand for data center space has increased dramatically this year as large technology companies have scaled up their cloud presence, and this has translated to strong performance for data center REITs.
Stock prices in the data center REIT segment had increased by 24.7% year-to-date as of Friday, according to Nareit. The largest data center owner, Equinix, has seen its stock rise 28.7% this year.
The industrial real estate sector has also experienced growing demand this year as e-commerce companies have scaled up their distribution networks in response to an increase in online delivery orders during the pandemic.
Industrial REITs have experienced an 8.4% year-to-date increase as of Friday, according to Nareit. One of the largest industrial owners, Prologis, has experienced a 9.4% increase in its stock price this year.
REITs that own telecommunications infrastructure, such as cell towers, have increased 12.8% year-to-date as of Friday, according to Nareit.
"All three of those areas are supporting the digital economy," Schnure said of industrial, data centers and infrastructure REITs. "They have very strong demand."