REIT Renaissance: The Long-Awaited Comeback Begins

REIT 'Dark Ages' May Lead to 'Renaissance'

A framework often credited to British economist Fred Harrison, the 4-Phase Real Estate Cycle is comprised of: 1) Recovery; 2) Expansion; 3) Hyper supply, and 4) Recession. As we'll discuss in this report, trends over the past several quarters indicate that the real estate cycle will finally transition from the "Recession" phase to the "Recovery" phase in 2025, with muted supply growth serving as a key "silver lining" to the brutal three-year bear market. Over the past eighteen months, real construction spending on commercial properties (adjusted for the cost inflation) has seen its steepest decline since the Great Financial Crisis, pulling back roughly 5% in 2024. Real spending on residential properties, meanwhile, dipped more than 12% in 2023 before recovering in recent months as mortgage rates pulled back from 30-year highs. Combined, supply growth has effectively declined by 2.4% over the past 24-months, during which time Real Gross Domestic Product - which has a strong correlation with real estate demand - has increased by roughly 7%.

Consistent with the "recovery" phase of the real estate cycle, commercial property values have stabilized in recent quarters following a substantial drawdown during the "recession" phase. Green Street Advisors' data shows that private-market values of commercial real estate properties dipped 22% from the April 2022 peak to the December 2024 bottom, and have recovered steadily since then, posting a +4.8% increase in 2024 and have been flat so far in early 2025. By comparison, the peak-to-trough drawdown in this valuation index during the Great Financial Crisis was 30%. We've noted that the 20-25% drawdown level is a critical "capitulation threshold" - a level that matches the maximum Loan-to-Value ("LTV") ratio accepted by conventional commercial real estate lenders. With real estate valuations still hovering around the 20% drawdown threshold - and steeper within some property sectors, including office - distress will remain elevated within the most highly-levered segments of private markets. Defaults tend to peak in the final stage of the "Recession" phase but remain elevated into the early stages of the "Recovery" phase, a period that is generally fertile with acquisition opportunities for entities with access to equity capital.

Of course, the interest rate and property valuation headwinds become very "real" when the underlying properties are financed with debt - particularly copious amounts of variable rate debt and secured debt collateralized by this (declining) value of the property. Wth the scars of the Great Financial Crisis still visible, most public REITs were "preparing for winter" for the last decade, often to the frustration of some investors who turned to higher-leveraged and riskier alternatives in recent years. Private market players and non-traded REIT platforms were willing to take on more leverage and to finance operations with shorter-term, variable-rate, and secured-debt debt - a strategy that worked well in a near-zero rate environment but quickly crumbles when financing costs double or triple in a matter of months. NAREIT reported earlier this year that nearly 50% of private real estate debt is priced based on variable rates, compared to under 8% for public REITs. We've observed significant pain inflicted on the handful of public REITs that entered this period with variable rate debt loads in the 20-30% range - still relatively low compared to typical private equity firms - resulting in double-digit percentage point drags on Funds from Operations ("FFO").

Access to long-term debt is perhaps the most distinct competitive advantage of the public REIT model, but it's an advantage that hardly gave public REITs much of an edge when debt capital was cheap and plentiful in the "zero-rate" economic environment of the 2010s. Compared to private institutions, publicly-traded REITs had far greater access to fixed-rate unsecured debt - which is usually in the form of 5-10 year corporate bonds. This allowed REITs to lock-in these fixed rates on 90% of their debt while simultaneously pushing their average debt maturity to nearly 7 years, on average, thus avoiding the need to refinance during these highly unfavorable market conditions. Even with the significant pullback in financing activity in recent months, the average term-to-maturity for public REITs is still over 6 years - well above the pre-GFC highs of around 4 years - and significantly above the weighted average term-to-maturity of around 3 years for private real estate assets. Hence, for many of the highly-levered players that lacked access to long-term capital, the trends observed in the chart below are magnified by a factor of 2-3x.

Deeper Dive: REIT Fundamentals

As noted, the pockets of distress are almost entirely debt-driven - and further isolated to the office sector - as nearly every property sector reported "same-store" property-level income above pre-pandemic levels. REIT company-level metrics have tracked this rebound in property-level performance relatively closely throughout the pandemic - with the exception of the highly-levered REITs that expect sharp FFO declines this year even as property-level cash flows remain healthy. REIT FFO ("Funds From Operations") has fully recovered the sharp declines from early in the pandemic, and in the fourth quarter, FFO was 22% above its 4Q19 pre-pandemic level on an absolute basis, and roughly 9% above pre-pandemic levels on a per-share basis. On a year-over-year basis, FFO/share was down -0.4% in Q4, however, resulting primarily from a drag from higher interest expense. Same-store Net Operating Income ("NOI"), meanwhile, was roughly 3.2% higher on a year-over-year basis in the fourth quarter, and 16% above the pre-pandemic level.

After recording the largest year-over-year decline on record in 2020 - which dragged the sector-wide occupancy rate to 89.8% - REIT occupancy rates have rebounded since mid-2020 back to 93.3% - toward the upper-end of its 20-year average of 90-94%. By comparison, occupancy levels dipped as low as 88% during the Financial Crisis and took three years to recover back above 90%. Retail REITs have been the noted upside standout on the occupancy-front, as store openings have significantly outpaced store closings over the past three years - a sharp departure from the "retail apocalypse" trends of the 2010s. Residential REITs have continued to report near-record-high occupancy rates in recent quarters - despite record levels of multifamily supply growth. Industrial REITs reported a moderation in occupancy rates to around 95% in Q4 from their record highs of nearly 98% in late 2022. Office REIT occupancy, meanwhile, has seen substantial declines since the start of 2020 and remained 500 basis points below pre-pandemic levels at 86.2% in the fourth quarter.

Powered by more than 120 REIT dividend hikes in both 2021 and 2022 - and another 80 dividend hikes in 2023 and 2024 - dividends per share have finally fully recovered from the wave of pandemic-era dividend cuts in 2020. In 2024, we tracked 85 dividend increases, and 2025 is pacing slightly ahead of 2024 in the early-goings. With FFO growth significantly outpacing dividend growth since the start of the pandemic, REIT dividend payout ratios declined to below 70% in Q4 - well below the 20-year average of around 80%. With a relatively low dividend payout ratio, the average REIT has built up a buffer to protect current payout levels if macroeconomic conditions take an unfavorable turn. As always, the sector average does mask some elevated payout ratios across several sectors: Mortgage REITs currently pay out about 95-100% of EPS, on average, while Cannabis REIT payout ratios are also elevated.

Deeper Dive: REIT Valuations & Growth

The extended stretch of REIT underperformance since early 2022 - combined with the nearly 20% increase in FFO during this time - pulled REIT valuations to the lowest level since the end of the Great Financial Crisis, but REITs aren't quite as "cheap" now as they were at "bottom" last June. For REITs, being "too cheap" can be a problem. Over most long-term investment horizons, "cheap" REITs tend to stay cheap via underperformance, and "expensive" REITs tend to stay expensive via outperformance. Valuations are a reflection of these REITs' cost of capital: highly valued REITs have access to cheap capital, while cheaper REITs must pay more to access capital. While modern equity REITs are more "dynamic" than a conventional bank, these "spreads" between cost of capital and return on capital are still critical. Further, equity valuations can and do play an important role in the ability of REITs to grow accretively: when REITs trade at persistent discounts to their private market-implied Net Asset Value ("NAV"), the "flow" of real estate tends to be from public markets and to private markets. Alternatively, when REITs trade with NAV premiums, the flow is positive- REITs are able to accretively acquire private market assets.

Lifted by the recent rally since mid-January, the average REIT now trades at an estimated 5% premium to its Net Asset Value - as implied by current private market valuations - the first time REITs have traded at NAV premiums since late 2021. Equity REITs currently trade at an average forward Price/FFO multiple of around 16.8x using a market-cap weighted average, which is roughly only slightly below the post-GFC average of 18.0x. The market-cap-weighted average, however, is somewhat distorted by the massive weight of higher-valued technology REITs, and on an equal-weight basis, REITs trade at a 15x median P/FFO multiple, which is near the lowest levels since the early 2000s. Equity REITs pay a dividend yield of 4.0% on a market-cap-weighted basis, but this dividend yield climbs to over 6.0% on an equal-weight basis, and roughly 8.5% when including mortgage REITs.

Deeper Dive: REIT Balance Sheets

The ability to avoid "forced" capital raising events has been the cornerstone of REIT balance sheet management since the GFC - a time in which many REITs were forced to raise equity through secondary offerings at "firesale" valuations just to keep the lights on, resulting in substantial shareholder dilution which ultimately led to a "lost decade" for REITs. While REITs entered this tightening period on very solid footing with deeper access to capital, the same can't necessarily be said about many private market players that rely on short-term borrowing or continuous equity inflows to keep the wheels spinning. Much the opposite of their role during the Great Financial Crisis, many well-capitalized REITs are equipped to "play offense" and take advantage of compelling acquisition opportunities if we do indeed see further distress in private markets from higher rates and tighter credit conditions.

Even as benchmark interest rates doubled from a year earlier and even with market values of REITs lower by 20-30% during that time, REITs balance sheets remain healthy by historical standards, merely giving back the incremental pandemic-era improvement. Debt as a percent of Enterprise Value still accounts for less than 35% of the REITs' capital stack, down from an average of roughly 45% in the pre-recession period - and substantially below the 60-80% Loan-to-Value ratios that are typical in the private commercial real estate space. Interest coverage ratios (calculated by dividing EBITDA over interest expense) have seen a shaper erosion over the past several quarters from its all-time highs set last year, however, but still stand at 4.1x, which roughly matches the coverage ratio at the end of 2019 and compares very favorably to the 2.75x average in the three years before the GFC period.

That said - not all REITs are created equal, and the broad-based sector average does mask some of the intensifying issues in several of the more at-risk sectors and among REITs that have been more aggressive in their balance sheet management. A handful of small and mid-cap REITs - some of which would be considered as having a rather strong balance sheet relative to similar private equity portfolios - have incurred significant charges to "fix" their floating rate debt exposure, while others have continued to roll the dice by maintaining a sizable chunk of variable rate debt. The BofA BBB US Corporate Index Effective Yield - a proxy for the incremental cost of real estate debt capital - has surged from as low as 2.20% in late 2021 to as high as 6.67% at the October 2023 peak and now sits at 5.40%. On a percentage basis, this represents a nearly 200% increase in interest costs on variable rate debt. The cost of equity - which we compute based on average FFO yields - is now 6.6% for the average REIT, up from a low of 4.4% in late 2021 but down from a peak of nearly 9% at the "bottom" of the REIT selloff in late 2023.

So naturally, REITs "hunkered down" in recent quarters as stock price valuations remained low by historical standards and in relation to private market-implied valuations, but have started to rebound in recent quarters. On an annual basis, the amount of capital raised in 2024 was up about 17% from a year earlier. REITs raised roughly $72B in capital through equity and debt offerings, with the majority of this capital raised coming via long-term debt offerings, which accounted for roughly 65% of the total capital raised in 2024 - above the historical average of around 50%. The largest common equity offering of 2024 was Lineage Logistics (LINE) $5.4 IPO, followed by the American Healthcare' (AHR) $773M IPO. Industrial REIT Prologis (PLD) was the most active REIT with roughly $5B in capital raising in 2024, followed by cell tower REIT American Tower (AMT) with over $3B raised. By property sector, industrial REITs accounted for the largest share of total capital raised in 2024, followed by data center and healthcare REITs.

REIT External Growth: Animal Spirits Awaken?

Distress for some is an opportunity for others, and we've begun to see - on a limited scale - public REITs with balance sheet firepower start to take advantage of capitulation from highly-levered players - a trend that will gather steam if debt markets remain tight and REIT NAV premiums hold. REIT external growth comes in two forms - buying and building. Acquisitions have historically been a key component of FFO/share growth, accounting for more than half of the REIT sector's FFO growth over the past three decades, with the balance coming from "organic" same-store growth and through ground-up development and redevelopment. With a historically large "bid-ask" spread for private real estate assets, REITs have been historically quiet on the portfolio-level M&A front with gross purchases of only $7.4B over the past year - the slowest annual total since late 2018 - but REITs did post their strongest two quarters of net acquisitions since 2022 in Q3 and Q4 of 2024.

At the property-sector level, net lease, industrial, and strip center REITs have been the most active acquirers of private market assets in recent quarters - accounting for more than half of total net purchases across the REIT industry. Most other REIT sectors have been more reluctant to "hit the bid" on slow-to-adjust private market valuations. Office and Cell Tower REITs have been the most significant "net sellers" over the past year. Several of the largest REIT acquisitions in 2024 emanated from Blackstone's (BX) nontraded fund, BREIT, which faced a wave of investor redemption requests in 2023 and 2024, prompting the need to raise capital to meet withdrawals. Since December 2022, BREIT has sold over $10B in assets to public REITs, including its most recent $1B sale of an 11-building apartment portfolio to Equity Residential (EQR) last December, and a $1B sale of an industrial portfolio to Rexford (REXR) last March. These deals follow a $5.5B sale of two Las Vegas casinos to VICI Properties (VICI) in 2023, an $800M sale of a Texas resort to Ryman Hospitality (RHP), a $2.2B sale of Simply Self-Storage to Public Storage (PSA), and a $950M partial sale of The Bellagio casino to Realty Income (O).

While Blackstone's BREIT has been a net seller, the private equity giant's other funds have continued to scoop up public REITs this year, acquiring another trio of REITs - Tricon Residential, Apartment Income, and Retail Opportunity - this year for a combined $17B. From 2020 through 2024, Blackstone and its affiliates acquired ten public REITs with a combined enterprise value of over $105B, paying an average premium of 35% relative to these REITs' prior closing price. Outside of these Blackstone-involved deals, M&A activity within the REIT sector has been almost non-existent in 2024, which followed a modest uptick in 2023 via a wave of public REIT-to-REIT mergers. Last year's wave was headlined by net lease REIT Realty Income's acquisition of Spirit Realty, healthcare REIT Healthpeak's (DOC) acquisition of medical office REIT Physicians Realty, and Extra Space's (EXR) acquisition of Life Storage. We also saw two smaller-scale consolidations in the strip center space: Regency Centers (REG) acquired small-cap Urstadt Biddle, while Kimco Realty (KIM) acquired mid-cap RPT Realty.

REITs have become some of the most active builders in the country over the past decade and - despite the slowdown in recent quarters - REITs still have nearly $39B of active development in the pipeline. Favorably, much of this pipeline is in the final stages of construction, as new groundbreakings have been few-and-far-between over the past few quarters given the unfavorable rate environment. The swelling of the development pipeline to the record-highs seen in 2023 was fueled by three property sectors - data center, industrial, and self-storage, but some of this inflated pipeline is the result of higher construction costs and lingering supply chain delays that prolong the development timeline. Retail REITs, on the other hand, have engaged in minimal development activity over the past several years - which has fueled the recent occupancy increases - while the pipeline in office has also pulled back materially over the last several quarters, as expected.

Takeaways: Silver Linings After Dark Ages

REITs are as "unloved" as ever following a truly forgettable three years dating back to the start of the Fed's rate hiking cycle. The recent REIT rebound has sparked hopes that the "renaissance," which has historically reliably followed these periods of real estate sector distress - is beginning to take hold, and muted supply growth will prove to be the silver-lining to the three-year bear market for REITs. Public REITs enter this "recovery" phase with historically cheap valuations compared to the broader equity market. REITs have underperformed the S&P 500 by a whopping 40 percentage points since the start of the Fed hiking cycle in 2022 - a historically remarkable underperformance gap. Importantly, it is valuations - not property-level fundamentals - that are responsible for the vast majority of this underperformance. But properties are only as strong as the balance sheet that supports them, and the uncomfortable unwind will continue for many highly-levered private portfolios. Macroeconomic conditions are aligning in an ideal manner for low-levered entities with access to "nimble" equity capital - conditions that maximize the competitive advantage of public, which these entities have been unable to exploit in the "lower forever" environment.

About the Author

David Auerbach boasts over two decades of experience in the securities industry, specializing as an institutional trader with a focus on Real Estate Investment Trusts (REITs), Equity and Preferred stocks, MLPs, ETFs, and Closed End Funds.

Based in Dallas, TX throughout his entire career, David currently serves as the Chief Investment Officer for Hoya Capital, managing the Hoya Housing 100 ETF (Ticker: HOMZ) and The High Yield Dividend ETF (Ticker: RIET). Previously, David held the position of Managing Director at Armada ETF Advisors, the sub-advisor for the Residential REIT ETF (Ticker: HAUS) and The Private Real Estate Strategy via Liquid REITs ETF (Ticker: PRVT).

Additionally, he acts as a consultant with IRRealized, LLC, focusing on corporate access in the REIT industry. David's industry journey includes roles at World Equity Group, Esposito Securities, and Green Street Advisors where he got his start in the REIT industry.

At Esposito Securities, he played a crucial role in building the REIT/Real Estate platform and worked extensively with institutional investors, Equity REITs, and ETF issuers.

Throughout his career, David has been quoted by reputable publications such as Bloomberg, WSJ, Financial Times, REIT.com, and GlobeSt.com. He has also made notable appearances as a featured guest on networks like Yahoo Finance, TD Ameritrade, and Bloomberg.

David holds a BBA in Finance from the University of Texas at Austin (May 1999) and an MBA in Finance from Southern Methodist University (May 2005). He maintains FINRA Series 7, 24, 55, and 63 registrations.

In his leisure time, David is an avid traveler, often found crisscrossing the country in pursuit of attending as many Phish concerts as possible.

Disclaimer

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.