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NREI Research Series

Still in a Sweet Spot?

Publicly-traded REITs have enjoyed a strong run. NREI’s latest research examines the current investment climate.

Despite intensifying concerns about the maturity of the current commercial real estate cycle, publicly-traded REITs remain on solid footing and have good options for deploying their capital.

That is the conclusion of NREI’s third research survey exploring the state of publicly-traded REITs.

Among the findings:

  • Industrial REITs strengthened their hold as the most favored asset class, while retail REITs stayed firmly on respondents’ “sell” lists.
  • More respondents view the climate as being amenable to mergers and acquisitions than during the previous two years, but respondents are less sure about REITs being net buyers on a property-level basis.
  • Respondents continue to endorse property-level debt as the best avenue for tapping capital markets in the current environment.
  • Most respondents think REITs should focus on paying down debt.

What to do

There is not much certainty in the market on what REITs will do to manage their portfolios. Respondents were essentially evenly split in saying that REITs would be net acquirers of property (23 percent), net sellers (26 percent), make no changes (29 percent) or that they weren’t sure what REITs would do (22 percent).

However, there is general consensus among survey respondents that now is a good time for mergers (56 percent). That is up from 47 percent of respondents that indicated it was a good time for REITs to pursue tie-ups in 2017. About one-third of respondents (33 percent) said they aren’t sure whether now is a good time, while 11 percent said it was a bad time for mergers.

In terms of deploying capital, more than half of respondents said REITs should be paying off debt (51 percent). That’s up from 39 percent in 2017.

In fact, recent months have been an active time for REIT mergers.

First, General Growth Properties Inc., a mall REIT, agreed to a buyout offer from Brookfield Property Partners this March. Then, healthcare REIT Welltower Inc. partnered with not-for-profit healthcare provider ProMedica to acquire Quality Care Properties, which is focused on post-acute, skilled nursing and memory care/assisted living properties. And Prologis Inc., the largest warehouse owner, also moved to take over a smaller rival, DCT Industrial Trust Inc. Most recently, Blackstone Group LP agreed to acquire Gramercy Property Trust, which owns industrial real estate in the U.S. and Europe, in a cash deal valued at $7.6 billion. 

In addition, about half of respondents (46 percent in 2018 vs. 47 percent in 2017) continue to endorse REITs redeveloping or repositioning assets. Fewer respondents in this year’s survey said REITs should acquire assets (27 percent vs. 33 percent in 2017). About one-fifth of respondents said REITs should be investing in core operations (21 percent) or buying back shares (20 percent).

In open-ended answers, respondents echoed some of those same points, identifying mergers and acquisitions as a potentially fruitful strategy. But some pointed to additional opportunities for REITs in the current economic climate.

REITs can be “capitalizing on the sale of certain properties while we are at the peak of this cycle, especially the ones that they may not want in their portfolio long term or during a recession,” one respondent wrote.

Picking favorites

For the second consecutive year, industrial REITs topped respondents’ “buy” lists. This year, a whopping 49 percent of respondents named industrial REITs as one of the sectors that would be at the top of their buy lists. That is up from 46 percent a year ago. (Respondents were allowed to select multiple asset classes.)

Multifamily REITs again took second place, named by 36 percent of respondents (down from 39 percent a year ago). Medical office REITs held steady in third place at 35 percent. Retail REITs, surprisingly, moved up from 11 percent in 2017 to 15 percent in 2018. Hospitality REITs, meanwhile, dropped to just 9 percent. 

“The overall business environment is very healthy, creating multifamily and industrial stability, thus opportunities exist in these areas,” one respondent wrote.

Conversely, retail REITs again are the most frequently named answer on respondents’ “sell” lists. In all, 56 percent of respondents named retail REITs on their lists—the same mark as in 2017. That was 25 percentage points above the next most frequently-named sector, office REITs. Multifamily REITs—which had the unusual distinction of being popular on both respondents’ “buy” and “sell” lists in 2016 and 2017—dropped to being on 27 percent of respondents’ “sell” lists in this year’s survey.

Industrial and medical office REITs are at the bottom of “sell” lists at 9 percent and 8 percent, respectively.

Financial health

As in past years, survey respondents have favorable views of REIT balance sheets. Overall, 58 percent said that REIT balance sheets are “balanced” and another 17 percent said they have room to take on more debt. Only 25 percent feel that REIT balance sheets are “highly levered.” Those numbers represent slight improvements over the past two years.

Respondents continue to view capital markets as being stable for REITs. Roughly one third of respondents said the availability of both equity (35 percent) and debt (42 percent) is unchanged from a year ago. About one fifth of respondents said equity (22 percent) and debt (21 percent) are more widely available.

In terms of raising capital, for the third consecutive year respondents endorsed property-level debt (50 percent in 2018 vs. 46 percent in 2017 and 51 percent in 2016) as the best avenue for REITs given current market conditions. Another 31 percent endorsed equity issuance (compared with 37 percent in 2017), while only 16 percent said secondary debt issuance was the best avenue (flat from 2017).

“Continued availability of inexpensive debt should allow for balance sheet fine tuning and conducting strategic renovations of well-located assets when required,” one respondent wrote.

Reading the tea leaves

Looking ahead, respondents’ outlook on publicly-traded REIT stock prices is in line with past years’ expectations. Overall, 45.3 percent of respondents in this year’s survey said they expect that REIT stock prices will rise for the balance of the year, compared with 43.3 percent in 2017 and 46 percent in 2016. Roughly one-quarter of respondents (23.5 percent) said REIT stock prices will remain flat and 31.0 percent expect them to decrease. In all, the bulk of respondents’ expectations (89 percent) are that stock prices would rise or fall by less than 50 basis points in either direction.

In assessing total returns, sentiment is slightly more bullish. Just more than half of respondents (50.3 percent) expect REITs to grow their total returns during the balance of 2018. That’s up from 47.1 percent who had that assessment in 2017. In addition, 22.6 percent said total returns will be flat for the balance of 2018, while 27.0 percent said they will decrease.

Another open-ended question asked respondents to point to the biggest challenges facing REITs. The state of capital markets was a frequently-cited concern, with rising interest rates being the top challenge identified. But there were other thoughts as well.

“Capital markets have been brutal [and] will likely continue to [be] so; property valuations have been frothy for years, so likely REITs will need to focus more on development and rehabilitation in order to get their yields, taking on more execution risk in the process,” one respondent wrote.

Survey methodology: The NREI research report on the REITs was completed via online surveys distributed to readers in May. The survey yielded 350 responses. More than half of respondents reported their titles as Owner/Partner/President/Chairman/CEO/CFO. The results from the current research were compared against prior studies completed in 2016 and 2017. The 2016 survey yielded 350 responses and in 2017 it yielded 380 responses.

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