REITs have operated in a challenging environment throughout 2023, yet well-honed strategies of balance sheet discipline and transparency have enabled the sector to end the year on an optimistic note, with signs that 2024 may usher in interest rate stability and increased opportunity for REITs to boost external growth.
REIT.com recently spoke with Brian Jones at Neuberger Berman, Kristin Kuney at Goldman Sachs, Raj Rehan at BlackRock, and Jason Yablon at Cohen & Steers, to discover the opportunities and challenges that they see ahead.
How do you see macro fundamentals impacting REITs in 2024?
Brian Jones: Higher interest rates have certainly hurt investor sentiment toward REITs over the past two years. As we consider the range of outcomes for interest rates and economic growth in 2024, we believe a period of slower growth and more stable rates should lead to REIT performance determined more by individual sector and security operating performance, and less so by broader macroeconomic trends.
Kristin Kuney: We believe 2024 will bring less interest rate volatility, which should help re-open the transaction markets and provide valuable insight on asset valuations. We believe relative stability in rates would be enough for buyers and sellers to transact. A more functioning transaction market will likely shed light on the attractive valuation the public market is trading at, relative to the private market.
The silver lining in the substantial increase in interest rates over the past 18 months has been that it has drastically brought down new development, which should help keep fundamentals for existing assets in most sectors on better footing and give incumbent assets greater pricing power over the next couple of years.
Raj Rehan: The financial markets and domestic economy continue to send out mixed signals: a pandemic “rebooted” economy continues to confuse as it recalibrates; the global economy is operating in the “fog of war”; “goldfish-like” financial markets have struggled for direction, with material moves in risk free rates. The range of outcomes feels quite wide depending on the path of growth, inflation, the Federal Reserve’s reaction function, fiscal imbalances, geopolitics, and the political theater going into 2024’s presidential election.
Jason Yablon: REITs are well-positioned heading into 2024 as we move towards a macroeconomic environment that has historically been more accommodative for REITs. REIT fundamentals have remained resilient, and while growth is decelerating due to the lagged impact of tighter financial conditions coupled with pockets of supply, trends are still above long-term averages. In fact, we even saw REITs transition from being net sellers of assets to net acquirers as we entered 2023, showing that REITs are well-positioned to provide liquidity to the broader CRE market. We believe investors continue to be under-allocated to real assets overall.
What are likely to be some key themes in private versus public real estate investing?
Yablon: We believe the private real estate market is only halfway through its correction of valuations, whereas the REIT market has largely corrected. The price recovery of REITs typically leads private real estate by 12 to 18 months.
We think there is an opportunity in listed REITs currently and that selective opportunities will begin to emerge in private real estate over the next 12 to 18 months, and into the next few years.
We are also big believers that optimizing a real estate portfolio requires access to both listed and private markets and that recessions have historically created very attractive vintages in both listed and private real estate.
Rehan: As with prior cycles, REITs have led the way relative to private real estate. Through 2022, we saw REITs drop by ~30% while private real estate valuations continued to move up, this created a valuation gap that has remained through 2023. As with past cycles, this gap will close, likely with private real estate markets correcting further as public REITs find a bottom.
We have seen public REITs exercise an access to capital advantage over private market participants in 2023, allowing them to grow their businesses and advance their strategic goals in a value accretive manner. We expect this trend to continue in 2024.
Kuney: We see the NAV delta between the public and private markets compressing during 2024, as private funds are forced to mark their assets down to levels closer to where transactions are happening, which has been generally above appraisal cap rates over the past 12-plus months. Given the concern over valuation marks, private real estate equity funds may continue to see outflows as the disconnect between cap rates continue to be wide.
Given the greater access to financing and generally higher liquidity, public REITs may be able to acquire assets from the private market at discounted values, which could be accretive to cash flows and dividends.
Jones: While interest rate trends moderated in the fourth quarter of 2023, the lagging impact of a higher rate environment should be a key differentiator in terms of private versus public real estate investing. On the public side, lower average leverage ratios position public REITs to invest externally as transactions eventually begin to recover. Public REITs also may attract more investor interest in 2024 following two consecutive years of weak total returns, which have reset public REIT values to more attractive levels. The wide range of property types within the public markets may also gain more attention as we anticipate a wide dispersion of sector returns during a period of less robust underlying economic growth.
As you position your real estate funds for 2024, are you anticipating any property sector allocation changes?
Kuney: We currently favor tower REITs as we believe they became overly discounted on the concern of slowing revenue growth. The visibility of their operating income and low capital intensity of the assets are a powerful combination for strong, compounding returns for investors.
We also like data centers, given the very tight availability in the major data center markets. However, given current valuations after strong performance, further, near-term upside could be limited.
Multifamily could become more interesting as supply starts to fall and second derivative on rents improves, likely towards the mid/back half of 2024. Self-storage is similar; however, we see these trends happening potentially earlier than in multifamily. We believe single family rental (SFR) and manufactured housing will continue to produce superior results over the nearer term.
We also believe the fall off in industrial supply will lead to pricing power in the industrial REIT sector in the second half of 2024 and into 2025. Our view is that the market currently is not fully appreciating this dynamic.
Jones: If we receive more confirmation of the U.S. economy slowing further, we may add to our exposure in the health care sector where demand drivers lean more toward demographics, specifically the aging of the baby boom generation, than near term cyclical economic trends.
Additionally, if interest rates continue to moderate in 2024 the net lease sector could become more attractive given the sector’s greater rate sensitivity. We will continue to closely monitor the apartment sector, which has suffered from elevated new construction recently. If apartment deliveries moderate as expected in the second half of 2024, increasing exposure to apartments could be warranted.
How are you incorporating considerations of physical climate risk into your portfolio management?
Kuney: We may incorporate an assessment of potential climate risks, in either our estimation of the potentially lower, longer term operating income impact and/or higher expenses from larger insurance costs. Also, we may increase our capex reserve for properties more at risk of climate events and watch to see if longer term demand to these areas changes due to increased climate risk.
Rehan: As the costs of climate change emerge, particularly a rise in extreme weather events, they will affect market fundamentals, cashflows, and value. We are closely monitoring capex and operating expenditure to assess how these trends evolve as authorities push for carbon reduction. Our top priority remains staying true to our fiduciary duty. The best investment solution is one driven by client objectives.
Jones: We regularly estimate the potential valuation impact of a two-degree increase in average temperatures for the holdings in our various strategies. Climate risks, while most explicitly relevant for REITs with coastal exposure, impact all property sectors and regions of the country.
We are also monitoring how greenhouse gas emissions are increasingly being regulated by state and local governments. These emerging regulations may lead to retrofitting costs for REITs and may have profound implications for energy intensive sectors such as data centers.
Yablon: We incorporate climate related matters into our investment risk management framework and investment process by including ESG considerations as part of our standard research process. We have two internal working groups that focus on transition and physical risks. Companies that set a clear climate transition pathway can make strategic decisions that may enhance financial and operating performance, reduce operational and reputational risks, and improve long term shareholder returns.
Are there specific priorities you want to see REIT management teams focus on in the year ahead?
Jones: Active management and optimization of real estate portfolios should always be a priority for REIT management teams, but during a period of slowing economic trends optimizing these activities takes on additional significance.
Balance sheet management should also remain a top priority as flexible low leverage balance sheets help cushion the impact of higher interest rates and position REITs to capitalize on external growth opportunities when the time is right.
Rehan: Public REITs have proven to be a highly effective model, enabling the best real estate operating platforms in the country to thrive and grow. The critical drivers, in our view, have been capital access, efficiencies of scale, and the ability to attract, incentivize, and retain the best talent in the business. We encourage REIT management teams to continue advancing this advantage. Whether that be driving efficiencies through new technologies or remaining laser focused on people and organizational development.
Yablon: Over the last 20-plus years, REIT management teams have focused on their goals, increased transparency, and demonstrated discipline. These have resulted in strong historical returns for the market. REITs learned their lessons from the GFC and have been well-positioned from a fundamentals perspective in the current environment with stronger balance sheets, resilient cash flows, and lower loan to value ratios.
We encourage REIT management teams to continue prioritizing these attributes, while also setting their vision to be long-term oriented.
Kuney: When speaking with all REIT management teams, we must feel very comfortable with their balance sheet and capital allocation strategies. We need to ensure management teams have a self-help business plan—one that is not predicated on rates going lower or on macro factors.
Capital discipline is always important but is paramount in this capital constrained environment. We want management teams who are clinical in their capital allocation, making sound longer term decisions that create value for all stakeholders.
Which property sectors are you most enthusiastic about for 2024, and why?
Jones: We favor sectors where we expect tenant demand and ultimately cash flow trends to remain resilient in a slower growth environment. The tower sector should have resilient cash flows as the continued roll out of 5G communications equipment by cellular service providers drives higher utilization of existing cell tower infrastructure.
We also favor the SFR sector as it benefits from the demographic wave of millennials entering their early thirties and starting to form families at the same time that higher interest rates and low for sale housing inventory limits their ability to purchase a home,
We also like the necessity-focused shopping center sector as retailers continue to recognize that store-based retailing remains a critical and highly profitable distribution channel.
Yablon: We’re most enthusiastic about next-gen property types, including SFR, data centers, and senior housing. We think SFR continues to be supported by rental housing demand due to affordability challenges in the purchase market and demographic tailwinds.
In senior housing, occupancies fell dramatically in early 2020 but have been steadily recovering. As the baby boomer population gets older, senior housing demand will grow while supply remains muted, leading to continued pricing power.
Meanwhile, data center REITs are well situated due to increasing investment in cloud computing and AI. We expect them to be early winners and longer-term beneficiaries of AI.
Rehan: Manufactured housing has shown resilience and stability over time, as it provides affordable and quality housing options for low and moderate-income households. The occupancy rates and rent growth of manufactured housing REITs have outperformed other property types over time, and we expect this to continue.
Capital investment and spectrum deployment of wireless carriers will continue to drive above average growth for tower REITs over a multi-year period. Concerns around the current slowing in tower growth is overblown in our view, as U.S. carriers are taking a 5G deployment pause that will ultimately restart.
We expect demand for industrial real estate to remain robust and to be further bolstered by nearshoring and domestic investment into strategic sectors like tech, energy, defense, and infrastructure. Supply chain disruptions and rising geopolitical tensions are pushing companies to seek more resilient supply chains that defend sovereignty. Powered in part by policy such as the CHIPS Act and the Inflation Reduction Act (IRA), this will provide opportunities for industrial REITs.
Are there other trends or developments that you will be watching, or that will inform your investment strategy in the coming year?
Kuney: Although it will likely be too early for any meaningful impact, we are watching if there is any effect to the workforce due to AI developments, positively or negatively.
Conversions between asset classes will remain a hot topic, especially as it relates to older office assets. We are also watching the impact of both supply chain reconfiguration and near-shoring, as well as the effects of the substantial fiscal stimulus from the IRA and CHIPS Act that may have impacts on certain regions and metros in the U.S.
Rehan: We think advances from here in AI are likely to be exponential as innovation snowballs. We may be just at the cusp of this intelligence revolution. Implications likely go beyond the near-term focus on productivity gains. We see the data center industry as uniquely positioned to benefit from digitization investment and technological evolution.
As baby boomers age, their need for health care services will grow through the end of this decade and through the next, setting up an attractive demand tailwind for health care REITs. Maturing millennials, on the other hand, are seeking larger spaces as they enter middle age but have remained in the rental market, which likely continues to benefit the SFR sector.
Yablon: AI is a transformative technology that has the potential to create winners and losers across the real estate investing landscape beyond data centers. Though still early, we believe AI has strong potential to be a net positive for more than half the investable universe for REITs, improving operational efficiency for sectors such as health care and hotels, while of course leading to increased demand for data centers and towers.
Jones: Whether it is the use of automated platforms to reduce personnel costs in self-storage or residential portfolios, or the growth of cloud computing and AI rollouts driving demand for data centers, technology’s impact on the real estate sector is rising.
We have also seen a pickup in REIT-to-REIT M&A activity in 2023, which could be supportive of REIT valuations as we head into 2024. The increase in M&A activity has us looking closely at REIT governance issues in respect to whether management incentives are well aligned with shareholders and if REITs are likely to employ takeover defenses, which we tend to find shareholder unfriendly.