State Of REITs: A Revival Is Brewing, If Rates Behave

Where Are We In The Real Estate Cycle?

Despite the recent outperformance, however, Equity REITs have lagged the S&P 500 by nearly 70 percentage points since the Fed's initial rate hike in March 2022 - a mind-boggling sum for a sector that has historically produced similar annualized total returns - fueling a historically wide valuation spread between REIT and S&P 500 earnings multiples. An easing of the "Rates Up, REITs Down" paradigm couldn't come a moment too soon. Commercial and residential real estate markets were the most direct transmission mechanism - or "punching bag" - of the Federal Reserve's historically swift monetary tightening cycle, which resulted in the largest increase in the Federal Funds rate in any two-year period since 1981 on an absolute basis and the single-most significant increase on a percentage basis. The most rate-sensitive equity market sector, REITs were hit by a "triple whammy" of rate-related headwinds: higher borrowing costs directly squeezed bottom-line profitability, elevated Treasury yields that eroded the relative appeal of dividends, and a higher cost of incremental capital that has made it near-impossible to accretively finance acquisitions. This highly challenging macro environment resulted in the worst three-year stretch of REIT underperformance in history.

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 - despite the interest rate fluctuations - with muted supply growth serving as a key "silver lining" to the brutal three-plus-year bear market. Construction spending data this week confirmed that 2025 recorded the first annual decline in total U.S. construction spending since 2011, reflecting the impact of higher interest rates and tighter financing conditions on private real estate development activity. The decline came despite continued strength in data center, infrastructure, and manufacturing construction, which helped partially offset sharp slowdowns in commercial and residential development. Over the past two years, 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% y/y. Real spending on residential properties, meanwhile, dipped more than 12% in 2023 before recovering in 2024 before again turning negative in 2025 as mortgage rates remained stubbornly elevated. 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 10%.

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' Commercial Property Price Index shows that private-market real estate values are higher by 2.1% year-over-year and have recovered 9.5% from the 2023 bottom. Even so, values remain 14.2% below the 2022 peak and 1.8% below 2019 levels, underscoring both the severity of the valuation reset and the incomplete nature of the recovery. Private-market values of commercial real estate properties dipped 22% from the April 2022 peak to the December 2024 bottom. 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. Trepp reported this month that the Special Servicing rate for CMBS loans - a forward indicator of potential future loan delinquencies - topped 10% in May for a sixteenth straight month, while its overall CMBS delinquency rate rose to 7.55% in May - matching its highest since the pandemic. That said, while delinquency rates remain elevated, actual default rates remain relatively contained, reflecting a continued willingness by lenders to modify, extend, and restructure loans rather than force property sales in a still-illiquid transaction environment. 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 sector seeing a meaningful rise in defaults is multifamily, driven largely by the heavy use of short-term floating-rate bridge debt among smaller owners that financed acquisitions and developments during the low-rate period. Another notable recent trend is the improvement in hotel delinquency rates, which are actually now below the multifamily sector in the Trepp series for the first time on record.

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, 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

Taking a step back, it was truly a forgettable four-year period for real estate equities dating back to the start of the Fed's rate-hiking cycle - a period that had seen historically low levels of "dynamism" across the sector, including the slowest three-year period ever for REIT capital raising activity (as a percent of market cap), the fewest number of REIT IPOs since the late-90s recession, and the first time ever in which the total number of publicly listed REITs declined for seven consecutive years. (1998 to 2003 saw six-straight years of declines) Today, there are 164 REITs in the FTSE Nareit All REITs Index - down from 222 at the start of 2021 and down from the peak of 225 in 2015. After increasing its weight in the S&P 500 in 17 of 20 years from 2000 to 2019, REITs' sector weighting in the major equity benchmark declined for a fifth straight year in 2025 and stands at just 2.2% today. Further, per the recent BofA Fund Managers Survey, REITs continue to be among the most "unloved" asset classes across global markets, with net underweight positions in REITs hovering in the -10% to -25% range continuously for three years.

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.

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 16% discount to NAV, while micro-cap REITs trade with a NAV discount of nearly 25%. 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

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 back to 93.2%, toward the upper end of the sector’s 20-year average range of 90-94%. By comparison, occupancy levels dipped as low as 87.8% during the Financial Crisis and took three years to recover back above 90%. Retail and residential REITs remain the clear upside standouts on the occupancy front, with retail occupancy near record highs at 97.2% and residential occupancy at 95.8%, up 20 basis points from last year despite record levels of multifamily supply growth. Industrial REIT occupancy remained steady at 93.2% following the post-pandemic normalization from historically tight levels, while storage occupancy improved modestly to 86.9%. Office REIT occupancy, meanwhile, rebounded 100 basis points year-over-year to 86.2%, but remains far below pre-pandemic levels and continues to lag the broader sector by roughly 700 basis points. Hotel occupancy also improved notably to 70.3%, up 250 basis points from last year, reflecting the continued recovery in business transient, group, and event-driven demand.

REIT company-level metrics have tracked this rebound in property-level performance relatively closely throughout the pandemic, with the exception of more highly levered REITs that have reported sharper FFO pressure 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 was 10.9% above 2019 pre-pandemic levels on a per-share basis in Q1 2026. On a year-over-year basis, FFO/share was higher by 3.5% in Q1, as solid property-level growth helped offset the lingering drag from higher interest expense. Same-store NOI, meanwhile, was 20.5% above 2019 levels and 3.8% higher year-over-year, reinforcing that the sector’s operating fundamentals remain substantially healthier than public-market valuations imply. Dividends per share were 6.5% above pre-pandemic levels and increased 3.1% year-over-year, reflecting a measured but broadening recovery in shareholder distributions following the pandemic-era cuts.

Powered by another 85 REIT dividend hikes in 2025 and 55 so far in 2026, sector-wide dividends per share have fully recovered from the wave of pandemic-era dividend cuts in 2020. With FFO growth keeping pace with dividend growth, REIT dividend payout ratios remained healthy at 74.9% in Q1 2026 on a trailing twelve-month basis - below the 20-year average of 78%. This improved coverage reflects both disciplined capital allocation and a cautious approach to dividend increases during a period of heightened macroeconomic uncertainty. With payout ratios still sitting below long-term averages, the typical REIT has built up a cushion to protect current dividend levels should economic conditions soften. At the same time, this relatively conservative payout also provides room for continued dividend growth if operating trends remain constructive. That said, the healthy sector-wide average masks pockets of elevated payout ratios, particularly among mortgage REITs, while a handful of individual equity REITs continue to operate with tighter-than-comfortable coverage ratios.

Deeper Dive: REIT Valuations & Growth

While REIT valuations remain historically low relative to the broader equity market, green shoots have become increasingly visible across the REIT landscape in recent months, highlighted by improving transaction activity and a meaningful pickup in public listings following a multi-year lull. REIT IPO and listing activity has improved notably over the past two years, with five public listings in 2024, three in 2025, and three already in 2026. This year’s listings include Janus Living (JAN) - the senior housing spin-off from Healthpeak (DOC) - which raised roughly $840M, National Healthcare Properties (NHP), which raised roughly $460M, and Blackstone Digital Infrastructure (BXDC), which raised roughly $1.8B. The success of the Janus Living listing was particularly notable, as the deal priced toward the high end of its indicated range and suggested that Healthpeak was able to unlock significant value from a cash flow stream that had been undervalued inside the broader diversified REIT structure. Perhaps most importantly, the improving IPO backdrop reinforces that the public REIT model still works - and can be a highly effective structure when conditions are favorable - leveraging premium valuations and access to equity capital to fuel a self-reinforcing cycle of accretive acquisitions, portfolio expansion, and sustained market-cap growth.

REITs largely “hunkered down” over the past several years as public market valuations remained depressed relative to both historical norms and private market-implied property values, limiting the attractiveness of issuing equity to fund external growth. As a result, many REITs focused on balance sheet preservation, asset recycling, and internal growth while waiting for capital market conditions to improve. Activity has begun to rebound from the 2022 lows, but remains well below the 2019-2021 pace as REITs continue to wait out the Fed tightening cycle. REITs raised roughly $79B in total capital in 2025 - 9% above the prior year - but still roughly 50% below 2019-2021 levels. Debt issuance remained the dominant source of capital, accounting for roughly $44B of the total, while common equity accounted for roughly $16B, ATM issuance accounted for roughly $15B, and preferred equity accounted for roughly $2B. Through April 2026, REITs had raised roughly $21B, including roughly $10B of debt, $7B of ATM issuance, $4B of common equity, and minimal preferred issuance. The mix underscores that capital access has improved, but still-discounted equity valuations continue to make traditional common equity issuance selective rather than broad-based.

Distress for some is an opportunity for others, and we have begun to see public REITs with balance sheet firepower take advantage of capitulation from highly levered players - a trend that should gather steam if debt markets remain tight and the emerging pockets of 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 ground-up development and redevelopment. After a historically slow pace from mid-2023 to mid-2024, transaction activity has improved in recent quarters. REITs reported $15.9B in acquisitions in Q1 2026 and $10.8B in dispositions, resulting in a net purchase volume of $5.1B. On a trailing twelve-month basis, REITs completed $88.0B in acquisitions and $72.2B in dispositions, resulting in net purchases of $15.8B. The rebound remains measured rather than aggressive, but REITs are again finding ways to grow externally, recycle capital, and arbitrage the public-private valuation gap.

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. These sectors have generally maintained the strongest balance sheet flexibility and continue to see acquisition opportunities where public market cost of capital compares favorably to still-elevated private market pricing. Healthcare REITs have been particularly active buyers of skilled nursing and senior housing assets, while industrial REITs have continued to selectively add logistics facilities despite moderating rent growth. Most other REIT sectors have been more reluctant to “hit the bid” on slow-to-adjust private market valuations, opting instead to focus on balance sheet strengthening and internal growth. Office, Manufactured Housing, and Apartment REITs have been the most significant net sellers over the past year, reflecting sector-specific capital allocation priorities. Office REITs continue to dispose of non-core properties and reduce leverage amid ongoing uncertainty around demand for workspace, while manufactured housing and apartment REITs have taken advantage of private market demand to recycle non-core assets at attractive valuations.

REITs have become some of the most active builders in the country over the past decade, but the development pipeline has pulled back sharply from its 2022 peak as higher interest rates and tighter development economics have slowed new starts. Excluding data centers, the REIT development pipeline stood at $25.79B in Q1 2026, down roughly 40% from 2022 levels. Relative to 2019, the total pipeline excluding data centers is lower by 32%, with retail down 47%, office down 50%, healthcare down 53%, self-storage down 15%, residential down 4%, and industrial roughly flat. Data centers are the major exception, with the pipeline up 481% from 2019 as AI and cloud demand continue to overwhelm available capacity. Favorably, much of the non-data-center pipeline is now in the final stages of construction, while new groundbreakings have been limited across most sectors. Taken together, the sharp slowdown in new starts suggests that supply growth across most property sectors should moderate meaningfully in 2026 and 2027, providing a more supportive fundamental backdrop for existing landlords.

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 the tightening period in 2022 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 4.6x, 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 5.31%. 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 5.96% 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.

Takeaway: REIT Revival Is Brewing, If Rates Behave

REITs have refused to break in 2026 despite oil-driven inflation pressure, rising Treasury yields, and a Fed narrative that flipped from multiple rate cuts to potential hikes. The “Rates Up, REITs Down” regime has weakened, with REIT-rate correlations falling sharply as fundamentals, strategy, capital allocation, and valuation catalysts increasingly drive performance. M&A has helped break the rate-driven narrative, helping to validate the public-market discounts to NAV, while capital markets are also reopening in a more meaningful way, highlighted by the successful IPO of Janus Living this past quarter and improving transaction activity. Property-level strength has been another key driver, with every major REIT sector reporting positive Q1 NOI growth both year-over-year and relative to pre-pandemic levels. Meanwhile, dividend growth has reinforced the recovery, with 55 REITs raising payouts versus 6 cuts, supported by sub-75% FFO payout ratios and improving dividend coverage. At the same time, supply growth is poised to ease, with development pipelines across most property sectors now rolling over after a wave of post-pandemic construction. The combination of moderating deliveries and still-solid demand should provide a supportive backdrop for REIT operating fundamentals, but ultimately, a period of sustained REIT outperformance - as we saw in the mid-2010s - will require the long-awaited normalization of long-term interest rates to a level between the zero-rate world of ZIRP and the pandemic-era inflation shock that followed.

About David Auerbach

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.