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Listed REITs are now in a position to provide liquidity to the broader commercial real estate market.
The transaction recently announced between BREIT, a non-traded REIT (NTR) managed by Blackstone, and Realty Income (NYSE: O) for the Bellagio Casino is the fifth recent example of listed REITs acquiring private assets and providing liquidity to the broader commercial real estate (CRE) market, including NTRs. Realty Income’s $950 million cash investment in the property is a mix of equity and preferred stock.
Other recent examples are VICI Properties acquiring the remaining 49.9% stake in MGM Grand and Mandalay Bay from BREIT for nearly $1.3 billion, Prologis acquiring a $3.1 billion industrial portfolio from Blackstone, Public Storage acquiring Simply Self Storage from BREIT for $2.2 billion, and Ryman Hospitality Properties acquiring the JW Marriott San Antonio Country Resort & Spa from BREIT for $800 million(1).
These transactions contrast with those in 2022, in which listed REITs were net sellers of property when private funds were net buyers. It is important to remember that the public markets force discipline on listed REITs, typically providing signals through to their cost of equity capital. They historically sell before private market valuations correct lower and acquire as private valuations are declining given the lead/lag relationship between the public and private markets(2). Listed REITs were net acquirers in 2010-2014 during the early phase of the business cycle and net sellers from 2015-2022 during the latter stages of the business cycle.
This cycle has played out in a similar fashion. Private real estate, as measured by the NCREIF ODCE index, declined -2.7% in the second quarter. That’s the third consecutive quarter it has dropped, and private real estate is now down -10.4% from its peak in the third quarter of 2022. By comparison, listed REITs, as measured by the FTSE Nareit All Equity REITs Index, have increased for three consecutive quarters. They’re now up 13%, as of the end of 2Q23, from their trough—which was also the third quarter of 2022. That private peaked and listed troughed at the same time, based on history, is no coincidence.
We believe the valuations of recent transactions were fair and do not suggest that listed REITs are buying assets cheap. However, these transactions are important to note for several reasons.
We believe they demonstrate the relative strength of listed REITs relative to other commercial real estate owners, which will allow listed REITs to capitalize on future opportunities as pricing becomes more attractive. We also believe there are select opportunities in the private real estate market beginning to emerge for investors with access to capital.
Listed REITs are now in a position to provide liquidity to the broader commercial real estate market for the following reasons:
First, listed REITs have strong balance sheets. On average, they have loan-to- values of less than 35%, and more than 86% of their debt is fixed for a term of more than six years(3). This puts them in a position of strength compared with other commercial real estate owners, and it should help mitigate the impact of rising interest rates (which we estimate will be only a –1.4% annual impact on earnings, as debt costs refinance higher.)
Second, listed REITs entered the economic slowdown at the start of this year in relatively healthy positions due to favorable supply/demand dynamics. The sector posted same-store net operating income (SS-NOI)(4) growth of 5% in the second quarter of the year, according to Nareit—well above the historical average of 2.5%—due to stable supply and demand and their in-place leases.
Finally, listed REITs have access to diverse sources of capital, and this has been important as banks have reduced their lending. For instance, listed REITs have been active issuers of senior unsecured bonds in 2023 with 32 deals totaling almost $22 billion over the first seven months of the year and about $11 billion of equity. They also have established revolving lines of credit that they can draw down upon if necessary. Finally, while banks may be pulling back, other lenders like life insurance companies are more active.
The bottom line is that listed REITs have the ability to issue equity and raise debt more efficiently than many other owners of commercial real estate.
One final and noteworthy point: We believe private real estate valuations have further to fall. In fact, we believe private property valuations could decline 20–25% in total this cycle—significantly more than the 10–15% decline that has occurred in the last year.
As this repricing occurs, it will create select opportunities for investors in private amid what we believe may be a multi-year period of property value markdowns and entry points.
(1) The mention of specific securities is not a recommendation or solicitation to buy, sell or hold any particular security and should not be relied upon as investment advice. As of June 30, 2023, Cohen & Steers owned Realty Income, Prologis, and Public Storage Securities in certain investment accounts. Reference to Blackstone Real Estate Income Trust (“BREIT”), Realty Income Corporation, VICI Properties, Inc., Prologis, Inc., Ryman Hospitality Properties, and Public Storage is made because as of August 25, 2023, they participated in the five largest deals that added liquidity to the commercial real estate market in the past nine months. This is not an offer of BREIT, and BREIT is not distributed by Cohen & Steers or any affiliated broker dealer.
(2) At December 31, 2022. Source: Thomson Reuters Datastream, Cohen & Steers, and Bloomberg.
(3) At March 1, 2023. Source: Green Street, Cohen & Steers.
(4) Net operating income (NOI) is a calculation used to analyze the profitability of income-generating real estate investments.
Head of the Private Real Estate Group James Corl spoke with Institutional Investor about the emerging opportunity within private real estate as the asset class reprices and why this might be the most attractive entry point into private real estate since the GFC.
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Relevant Index Definitions:
An investor cannot invest directly in an index and index performance does not reflect the deduction of any fees, expenses or taxes. Index comparisons have limitations as volatility and other characteristics may differ from a particular investment. The FTSE Nareit All Equity REITs index is a market capitalization-weighted index of U.S. equity REITs that meet certain criteria. The index contains all tax-qualified REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real property that also meet minimum size and liquidity criteria. The NCREIF Fund Index - Open End Diversified Core Equity (NFI-ODCE) is an index of investment returns of the largest private real estate funds pursuing lower risk investment strategies utilizing low leverage and generally represented by equity ownership positions in stable U.S. operating properties diversified across regions and property types. The NFI-ODCE (pronounced as “odyssey”) has been widely used since 1978 to track institutional core private real estate returns.
Risks of Investing in Real Estate Securities. Risks of investing in real estate securities are similar to those associated with direct investments in real estate, including falling property values due to increasing vacancies or declining rents resulting from economic, legal, political or technological developments, lack of liquidity, limited diversification and sensitivity to certain economic factors such as interest rate changes and market recessions. Foreign securities involve special risks, including currency fluctuations, lower liquidity, political and economic uncertainties, and differences in accounting standards. Some international securities may represent small- and medium-sized companies, which may be more susceptible to price volatility and less liquidity than larger companies. No representation or warranty is made as to the efficacy of any particular strategy or fund or the actual returns that may be achieved.
Risks of Investing in Private Real Estate. Private real estate investments are illiquid and susceptible to economic slowdowns or recessions and industry cycles, which could lead to financial losses and a decrease in revenues, net income and assets. Lack of liquidity in the private real estate market makes valuing underlying assets difficult. Appraisal values may vary substantially from a price at which an investment in real estate may actually be sold.
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