REITs Strike Back: Defying Rates, Riding the HALO Trade Into Recovery

Where Are We In The Real Estate Cycle?

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 has finally begun to transition from the "Recession" phase to the "Recovery" phase in recent months - despite the interest rate fluctuations - 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% this year. Real spending on residential properties, meanwhile, dipped more than 12% in 2023 before recovering in 2024 but again turning negative in 2025 as mortgage rates remained stubbornly elevated. Combined, combined supply growth has effectively declined by 5% 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 8%.

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 5% increase in 2024 and 2.5% in 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. While overall valuations have rebounded from that critical 20% drawdown threshold, some property sectors remain firmly in that "danger zone" in which defaults would be expected to remain elevated. 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.

A real estate portfolio is only as good as the balance sheet that finances it. And while public REITs may own the best house in the neighborhood with balance sheets that are the envy of the institutional real estate world, they are certainly not immune to the impacts of the lingering rate-driven distress around them. "Hope" has been the only strategy for many highly levered property owners amid a dearth of buying interest and limited capital availability—"hope" that interest rates recede before their "debt clock" expires. And for an increasing number of borrowers—especially those reliant on high-cost variable-rate debt—the clock hit midnight. Trepp reported this month that the Special Servicing rate for CMBS loans—a forward indicator of potential future loan delinquencies—topped 10% in February for a thirteenth straight month, while its overall CMBS delinquency rate rose to 7.14% in February - a tick below its highest since the pandemic. That said, while delinquency rates are very elevated, actual default CMBS rates remain on the low side, historically speaking, with the lone exception being the office sector. Fitch’s latest data shows that default rates are around 3.3% - up from lows of around 1.75% in late 2022—but actually still below the roughly 3.5% average in the three years preceding the pandemic (2017-2019). Apart from office, the only other segment that has seen a material increase in loan defaults is multifamily—a function of the high variable rate debt utilization rate resulting from its relative ownership skew towards smaller "mom and pop" investors.

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.

Valuations: REITs Remain Historically Cheap

Underperformance from real estate equities in a persistently elevated interest rate environment is not unwarranted, given that the two prior rate hike cycles that exceeded 400 basis points - the late 1980s cycle that sparked the Savings & Loan Crisis and the mid-2000s cycle that sparked the Great Financial Crisis - resulted in significant distress and disruption across the real estate industry. But the cumulative 70-percentage-point performance gap between REITs and the broader equity market in this three-year stretch is nevertheless remarkable, given the historical performance correlations: on a 15, 20, 25, and 30-year basis, REITs and the S&P 500 have delivered annualized total returns that are within about 4 percentage points. By comparison, the rolling relative performance spread (VNQ minus SPY) during the Great Financial Crisis peaked at around 20 percentage points in early 2009, and REITs closed the gap over the subsequent three years and ultimately climbed to fresh record highs by early 2022 - effectively the same time as the full rebound in SPY.

A theme we'll emphasize throughout this report, valuations—not necessarily fundamentals—are responsible for the vast majority of the underperformance during this "REIT Dark Age," setting the stage for a sustained REIT rebound in the quarters and years. 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 in late 2023, and while REITs aren't quite as "cheap" now as they were at the bottom, we see substantial upside in the mid- and small-cap REITs - those that have been hit most directly by the "capital starvation" inherent with the Fed's restrictive policy course. On a market-cap-weighted basis, REITs trade at a 16.8x median P/FFO multiple, below the post-recession average of 18.0x. On an equal-weight basis, however, REITs trade at a 14.3x P/FFO multiple, also well below the post-GFC average of around 16.0x.

Consistent with the deeper discounts offered by smaller-cap REITs, we note that Equity REITs pay a dividend yield of 3.9% on a market-cap-weighted basis, but this dividend yield climbs to over 6.5% on an equal-weight basis and roughly 8.5% when including mortgage REITs. And while the average REIT now trades at an estimated 10% discount to its Net Asset Value, small-cap REITs trade at an estimated 19% discount to NAV, while micro-cap REITs trade with a NAV discount of nearly 30%. That said, for REITs, being "too cheap" can be a problem - especially in an elevated interest rate environment. 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. Over most long-term investment horizons, "ultra-cheap" REITs tend to stay cheap via underperformance, and "ultra-expensive" REITs tend to stay expensive via outperformance. We see particularly compelling valuations in the mid-cap "sweet spot" of the REIT universe, where companies are large enough to enjoy scale efficiencies but still small enough to capture outsized growth opportunities, creating the highest upside potential as rates pull back.

Deeper Dive Into REIT Fundamentals

As noted, the pockets of distress are almost entirely debt-driven—and further isolated largely to the office sector—as nearly every property sector reported "same-store" property-level income above pre-pandemic levels. REITs reported that "same-store" property-level operating income ("NOI"), on average, was 19.4% above pre-pandemic levels in the fourth quarter and up by 3.7% on a year-over-year basis. The residential, industrial, and technology sectors have been the upside standouts during this pandemic and post-pandemic period, with most of these REITs reporting NOI levels that are over 25% above 2019 levels. Retail REITs—which were struggling before the pandemic—have posted some of the more impressive property-level performance in recent quarters, while Senior Housing REITs have also enjoyed a swift NOI rebound since bottoming in early 2023. Underscoring the impact of interest rates and balance sheets relative to property-level fundamentals, even the struggling office sector reported same-store NOI that was 5.2% higher than in 2019.

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 rebounded since mid-2020 back to around 93%—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 rebound in occupancy rates back towards 95% after an early-year dip that brought rates down to around 93%. Office REIT occupancy, meanwhile, posted its largest quarterly rebound in nearly a decade in Q4, but remains about 600 basis points below pre-pandemic levels at 87%

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 have reported sharp FFO declines even as property-level cash flows remain healthy. REIT FFO ("Funds From Operations") fully recovered the sharp declines from early in the pandemic, and in the fourth quarter, FFO was 20% above its 2019 pre-pandemic level on an absolute basis and roughly 8% above pre-pandemic levels on a per-share basis. On a year-over-year basis, FFO/share was up 1.3% in Q4, as solid property-level growth helped to offset the lingering drag from higher interest expense. Dividends per share, meanwhile, are about 7% above pre-pandemic levels and were higher by 3.9% on a year-over-year basis. Roughly 60% of REITs reported year-over-year increases in FFO in the most recent quarter, while 60% of REITs reported year-over-year increases in same-store NOI.

Powered by another 85 REIT dividend hikes in 2025 and another 32 so far in 2026, sector-wide dividends per share have finally fully recovered from the wave of pandemic-era dividend cuts in 2020. With FFO growth outpacing dividend growth since the start of the pandemic, REIT dividend payout ratios remained at around 77% in the fourth quarter on a trailing twelve-month basis—below the 20-year average of around 80%. With a relatively healthy dividend payout ratio, the average REIT has built up a buffer to protect current payout levels if macroeconomic conditions take an unfavorable turn, but the very healthy sector average does mask some elevated payout ratios across several sectors - particularly commercial mREITs - and among some individual names.

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.

With 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—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 last 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").

Even as long-term benchmark interest rates doubled and even with market values of REITs lagging the broader equity market by 30-50 percentage points throughout the past several years, 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 sharper erosion over the past several quarters from their all-time highs in late 2022, however, but still stand at 4.45x, 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 micro-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—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 5.02%. 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 5.9% for the average REIT, up from a low of 4.0% in late 2021 but down from a peak of around 7% at the "bottom" of the REIT selloff in late 2023.

Deeper Dive: REIT Valuations & Growth

REITs "hunkered down" in recent years as stock price valuations remained low by historical standards and in relation to private market-implied valuations, but activity has started to rebound in recent quarters. On an annual basis, the amount of capital raised through mid-year was up about 50% from a year earlier. REITs raised roughly $72B in capital through equity and debt offerings through September, with the majority of this capital raised coming via long-term debt offerings, which accounted for roughly 65% of the total capital raised thus far in 2025—above the historical average of around 50%. The largest common equity offering of the past three years was Lineage, Inc.'s (LINE) $5.4B IPO in 2024, followed by American Healthcare's (AHR) $773M IPO. By property sector, industrial REITs have accounted for the largest share of total capital raised in 2025, followed by data center and healthcare REITs.

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 can hold for at least several quarters. 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 were historically quiet on the portfolio-level M&A front in 2024 with gross purchases of only $7B last year—the slowest annual total since late 2018—but REITs picked up the pace in 2025. REITs reported $25.0 in gross acquisitions in Q4 - the highest quarterly haul since Q1 of 2022 - while REITs sold $18.8 in assets, resulting in a "net buy" of $6.2B. Of note, the $18.8B in asset sales was the largest on record for a single quarter, underscoring the recent tack towards strategic dispositions that unlock shareholder value.

At the property-sector level, net lease, healthcare, and industrial 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, Manufactured Housing, and Data Center REITs have been the most significant "net sellers" over the past year.

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 over $35B 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 centers, 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: Pushing Through The Oil Shock

While REIT stock prices don't yet reflect it, we believe that macroeconomic conditions are evolving in an ideal manner for public REITs to finally exploit their competitive advantage—access to nimble equity capital and long-term fixed-rate debt—which was of little advantage in the "lower forever" environment. And while past periods of tight lending conditions were remembered as those of distress, they can rightfully also be remembered as periods of a significant revolution and rebirth that spanned many of the public REITs that exist today. The S&L Crisis of the late 1980s—which resulted in the failure of nearly a third of community banks and resulted in significantly constrained access to debt capital—spawned the dawn of the 'Modern REIT Era.' A second wave of REIT IPOs followed in the aftermath of 9/11 and again after the Great Financial Crisis as the limited access to (and high cost of) debt capital, combined with a lift in equity market valuations of public REITs, pushed otherwise distressed, highly levered private portfolios into the public equity markets, a theme that we could well see repeated in coming quarters. Select REITs demonstrate that the public REIT model still works and can be the most powerful real estate structure when conditions are right - utilizing premium valuations and equity access to drive a self-reinforcing cycle of accretive growth and outsized market-cap expansion.

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.