After a tumultuous 2020, bankers look ahead to 2021 and see fundamentals that are generally favorable for REITs.
11/18/2020 | By Robyn A. Friedman
REIT magazine: November/December 2020
As a tumultuous 2020 heads to a close, commercial real estate continues to react to the swift and pervasive impact of COVID-19. Some sectors have performed well, while others are facing challenges. The low interest rate environment is certainly helping and has led to a flurry of refinances on debt coming due, not only in 2020 but in years to come. IPO activity slowed, but opportunities remain, although investors have become selective. Meanwhile, foreign investment in U.S. real estate is expected to increase next year as investors seek a safe haven.
What is your general outlook for commercial real estate in 2021?
Jeffrey Horowitz: I start all of these conversations with a big caveat—the length of time that most of us are out of the office, and the impact of COVID-19. The longer the disease is impacting people, the more their behavior changes. Regardless, I still think many of the trends currently in place will continue.
For example, online shopping will continue to gain market share. This will be a detriment to retail assets, but a beneficiary for industrial assets. Single-family housing demand will grow, as will demand for data centers. The result is a market with a handful of sectors with positive growth and a number of sectors that will underperform.
Ernest Kwarteng: My outlook is one of cautious optimism for 2021. I expect it to be a reset year because 2020 was a wash given the pandemic. If you look at some of the recent trends, we are already seeing strong recovery as it relates to rent collection in some sectors, like net-lease, while for some sectors the road to recovery will be driven by a broadly available vaccine.
I expect GDP growth to be at the mid-single digit level. The outlook of strong economic growth and low interest rates in 2021 bodes really well for the real estate sector.
David Lazarus: Because of the Federal Reserve stimulus, liquidity in the entire economy has been much greater than in any prior economic recession or depression. The Fed was ready, and the recent past, particularly the global financial crisis, made them more prepared.
We are entering 2021 with a historically low interest rate environment and with real estate cap rates that have not at all adjusted to that most recent (Fed) move. We are still talking about cap rates and discussing real estate valuations in the same terms we did 12 or 24 months ago. That’s fine, but in a world where there is a 70 basis point 10-year Treasury, you have to start to question whether 4%, 5% or 6% cap rates shouldn’t be lower.
Greg Steele: Some sectors, the ones driven by the digital economy for example, will continue to do very well. Some of the other sectors that are tied to the travel and leisure economy are very dependent on the success of a vaccine and may recover over the next couple of years if a vaccine is widely introduced sometime in 2021.
There are other sectors, such as malls, which will continue to underperform because they’re dealing with not just the cyclical economic factors, but also the secular issues that were evident even before the pandemic hit.
Seth Weintrob: These days, real estate encompasses so many different parts of the economy, and different parts are going in different directions, so it’s hard to generalize other than to say we still see a huge amount of demand from investors for real assets.
From a fundamental outlook, it is very sector, situation, and geography specific. We will see some sectors do really well in a post-COVID economy, we’ll see some have struggles in the near term and then recover, and we’ll see some sectors that are going to have long-term struggles as they come out of this.
Where do you see interest rates moving next year, and what impact will that have?
Weintrob: We are in a lower-for-longer environment. There are some views that we’re going to start to see a little bit of a pickup of inflation given all of the liquidity pumped into the market by the Fed and Treasury in monetary and fiscal policy expansion, but the Fed is likely to keep interest rates lower for longer. This should have a strong positive impact on the valuation of all asset classes and, in particular, income-oriented assets like real estate, so long as leverage in the system does not get out of control.
Horowitz: I’ve been saying for many years now that interest rates are unlikely to be higher for the foreseeable future. That is true today. The level of debt in the country makes it almost impossible to raise rates any time in the near future. For real estate companies, that’s a positive because they’re borrowing at very low rates, which is a stimulus for their business.
Kwarteng: Rates have been low for a very long time. Given everything we’ve seen so far, including guidance from the Fed, negative rates in other parts of the world and the continued low inflation rates in the U.S., I expect rates to remain low. There’s a chance they may even move further down.
Steele: The Fed has guided us to very low interest rates for at least the next couple of years. If you look at the high likelihood that we will have low interest rates, the dividend yields on the REIT sector are still very attractive, currently averaging around 4%.
Many REITs are covering their dividends very comfortably, and there’s a line of sight on dividend growth with plenty of cushion. Low interest rates continue to be a positive factor for the REIT sector and for real estate.
What will 2021 bring for REITs in terms of equity and debt issuance?
Steele: We will continue to see strong capital raising in the REIT sector next year, assuming a continued economic recovery. There could be a bias for bonds, which has occurred so far this year.
All-in borrowing costs for public REITs are very attractive. We’ve seen REITs issue bonds and repay bank debt with new bond financing, retiring not just 2020 debt, but 2021, 2022, and 2023 debt. The math is favorable to do bond refinancing now. I think we’ll see a healthy amount of equity raised, but a lot of that will be sector-specific.
Lazarus: The debt markets for REITs have been wide open, and REITs have been hitting them hard, accessing capital in the unsecured debt markets and preferred stock markets. That capital should continue to be available to REITs.
Horowitz: Most REITs have refinanced their debt for 2020 through 2023, so I believe that investment grade and high-yield issuance will be lower unless there is significant growth by the companies.
I think the same is true with equity. Equity will be raised opportunistically for growth efforts, but it also could be raised for companies that are more troubled from a recapitalization perspective.
Weintrob: We will continue to see a lot of demand in both the public and private capital markets across equity and debt. It will be difficult in 2021 to match the debt raising activity that has occurred in 2020 because companies have taken advantage of record-low interest rates. The equity markets will see increasing activity and more IPO activity. The CMBS market will continue to improve and see a lot more issuance in 2021.
What do you expect in terms of IPO and M&A activity next year?
Kwarteng: We should see a meaningful pickup in the IPO market because the capital markets will remain supportive, and properly capitalized, well-managed companies in industries with strong fundamentals should be well received. I think it will take us at least through the second half of 2021 before we see a meaningful increase in CEO confidence to drive M&A activities.
Horowitz: As the REIT market is somewhat mature, there will be a small number of IPOs and a certain number of M&A transactions. The pipeline for IPOs is somewhat muted. It will be very sector-specific. M&A will continue to be episodic.
Lazarus: IPOs have been extremely difficult to rationalize because the private marketplace in real estate has been so much better than the public market pricing. The bar for IPOs is way higher than it used to be. Today, you need a much higher quality company, you need a much larger company, and you need to be thoughtful about your capital structure—it’s a much more mature market.
Steele: There will be some opportunities for IPOs. There is interest by investors in management teams that have prior experience in the public markets, a strong operating history, and can demonstrate the ability to compete effectively against their existing public peers—where they can generate free cash flow, demonstrate FFO, and dividend growth.
In terms of volume, we may see one or two large IPOs that are potentially in the pipeline, but I believe it will still be a relatively small number overall. Investors will continue to be highly selective.
Weintrob: We’re going to certainly see increases in both. The IPO market has been pretty slow over the past few years. The last five or six IPOs have mostly been net-lease REITs, but we’re starting to see our pipeline increase and broaden. In M&A, the pipeline will also improve substantially.
Do you think foreign investment in U.S. real estate will pick up?
Weintrob: Yes. One of the bigger foreign investors in the U.S. has been China. That’s fallen off a cliff, and I expect that to remain quiet over the next few years due to geopolitical tensions.
We used to also see a lot of inbound dollars come from Canadian investors, which has recently slowed down, but I would expect that to trend back up. We’ll see some of the slack taken up by significant foreign investment from Singapore and the Middle East.
Horowitz: I think that foreign investment will pick up, particularly by funds in certain countries, like Canada. My sense is Asia will decline.
Kwarteng: The U.S. continues to be the biggest and most attractive investment space for a lot of foreign-based investors. With interest rates below zero and tepid growth in most places outside the U.S., we should expect to see continued investments coming across the border.
Lazarus: I think there will be a pickup next year in foreign investment. We had a year in which international investment became enormously complicated by COVID. As we’re getting to a more mature phase of COVID, we are starting to see markets open up.
We continue to believe that the world is an uncertain place and a place where the rule of law is not uniformly applied, and we constantly see capital seeking the safety of U.S. assets, U.S. law, and U.S. currency.
What other issues do you think will have a significant impact on REITs next year?
Steele: I look at the large amount of dry powder that private equity funds have, the number of REITs trading below NAV. And the potential for privatizations. There will be continued pressure for management teams to take a look at the potential for take-privates and whether that makes financial sense, particularly since there have been a number of REITs that have traded below NAV for some time.
Kwarteng: While there is still uncertainty around the pandemic’s long-term impact. I remain optimistic that with a vaccine and the resulting end to social distancing, a rebound in leisure and business travel, and the return to restaurants and entertainment centers, there is a great deal to look forward to next year for REITs.
Lazarus: A potential increase in taxes. One of the things we’re going to deal with is municipalities that are struggling. We’ve got to fund the government somehow, and taxes are the only source of revenue they really have. The populism has gotten to a level where it has impacted public policy in a way that has definitely been directionally negative for owners of real estate.
Horowitz: Employment trends, demographic trends, and locational trends. Taxes could also have an impact on certain markets, with states such as Texas and Florida continuing to be winners.