Listed REITs were down for the first quarter as markets adjusted to a rise in real rates, but we believe the outlook is positive in hard, soft and no-landing scenarios.
KEY TAKEAWAYS
- Listed REITs are down for the first quarter with a rise in real rates proving to be a headwind, though returns in both February and March were positive.
- Eight out of eighteen listed REIT subsectors are positive this year despite the index being negative. The wide disparity in performance between sectors indicates an opportunity for active management.
- We remain positive on listed REITs as we see an attractive risk-reward profile across all three economic scenarios – a soft landing, no landing and a hard landing.
After a rally to end 2023, listed REITs are down for the first quarter. However, pullbacks are common after such significant rallies, and we believe listed REITs have a positive outlook across various economic scenarios this year – a soft landing, a hard landing, and no landing.
Three key data points support this view: Total returns of the listed REIT index in the first quarter. REIT performance by subsector. And our outlook for total returns from here.
1. Listed REIT total returns
U.S. listed REITs, as measured by the FTSE NAREIT All Equity REIT index, are down 1.3% through the first quarter of this year. By comparison, the market value-weighted S&P 500 is up 10.6%, and the equal-weight S&P 500 has risen 7.9%. Out of the 11 S&P 500 sectors, real estate is the only one that is down year-to-date.
However, it’s important to remember that the negative quarterly returns were driven by – 4.9% returns in January. Since then, listed REITs have risen for two consecutive months with March at 1.8% and February at 1.9%.
There are a couple of reasons for this underperformance.
First, it’s important to remember that listed REITs had a very big rally to end 2023. The sector returned nearly 12% in November 2023, which was the fifth best month ever, and nearly 9% in December, which was the nineteenth best month ever. This brought full-year returns in 2023 to more than more than 11%.
Despite the recent pullback, listed REITs still stand almost 23.5% above their 2023 trough.
We’ve previously pointed out that consolidation often occurs during prolonged rallies. Overall, we believe investors should see pullbacks as opportunities.
Second, the markets are pricing in what our economist, John Muth, refers to as a no-landing scenario where sticky inflation leads to only two to three interest rate cuts this year. That’s significantly lower compared to the seven to eight cuts that were expected just a few months ago.
At the end of March, there was a market implied probability of less than 60% there would be an interest rate cut in June compared to the 100% probability that was priced in at the end of last year. This dynamic has pushed real rates more than 15 basis points higher year-to-date, which has been a headwind to listed REIT valuations even as credit spreads have continued to tighten (Exhibit 1).
EXHIBIT 1
Recent rise in real rates has been a headwind to REITs
At March 31, 2024. Source: Bloomberg. Data quoted represents past performance, which is no guarantee of future results.
2. REIT subsector performance
Eight out of eighteen listed REIT subsectors are positive this year despite the index being negative.
Notably, there’s almost a 22-percentage point difference between the top and bottom- performing sectors. On one hand, specialty at 11.5%, regional malls at 11% and lodging at 5.6% are leading. On the other hand, diversified is down 10.4%, infrastructure is at -8.8%, and commercial mortgages are down 5.6 percent.
We believe this is an attractive market for alpha generation, and active management should be embraced.
EXHIBIT 2
REIT performance has varied widely by subsector
(Subsector Q1 returns)
At March 31, 2024. Source: Bloomberg. Data quoted represents past performance, which is no guarantee of future results.
3. The outlook for total REIT returns
We remain positive on listed REITs as we see an attractive risk-reward profile across all three economic scenarios – a soft landing, no landing and a hard landing. And over the medium to long term we expect annualized returns in the high single digits at the index level and double digits after considering alpha through active management.
For starters, as shown in this chart, it’s important to remember that listed REITs have historically generated greater than ten percent total returns in seven different years since 2008 across a range of economic scenarios.
EXHIBIT 3
REITs have delivered double-digit returns seven times since 2008
At December 31, 2023. Source: Preqin, FactSet and Cohen & Steers. Data quoted represents past performance, which is no guarantee of future results. (1) Current data for listed REITs, REIT Preferreds and Core is as of 12/31/2023; Value Add, Debt and Opportunistic is as of 09/30/2023
A soft landing, in which inflation slows without causing a recession that allows the Fed to cut interest rates, is obviously positive for listed REITs.
We see potential for double-digit returns in a soft landing for the index given our economic assumptions. Returns could rise to the high teens if real rates decline toward one percent. And keep in mind active management can deliver significant additional alpha above the index.
What we think is misunderstood is how listed REITs can do well in a hard-landing scenario. If that happens, real rates declining well below 1% would likely offset credit spreads widening and slowing growth. We see positive returns from here in such a scenario and the emergence of a significant opportunity if listed REITs sell-off in sympathy with the broader markets.
And a no landing scenario also is expected to produce positive returns as the market has already been meaningfully de-risked given only one to three interest rate cuts are now expected.
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ABOUT THE AUTHORS
Rich Hill, Senior Vice President, is Head of Real Estate Strategy & Research, responsible for identifying allocation opportunities in both listed and private real estate and related thematic and strategic research.
FURTHER READING
The Retail Renaissance has arrived in private real estate investing
Values of open-air, necessity driven shopping centers have bottomed; a reality that most investors have yet to fully recognize.
A new market regime for REITs
A regime shift to lower rates is a favorable backdrop for REITs, in our view.
The Real Estate Reel: The potential benefits of blending listed REITs and private CRE
Adding listed REITs at certain levels to a private real estate allocation has been shown to increase performance, reduce volatility, and limit drawdowns.
Data quoted represents past performance, which is no guarantee of future results. The information presented does not reflect the performance of any fund or account managed or serviced by Cohen & Steers, and there is no guarantee that investors will experience the type of performance reflected. There is no guarantee that any market forecast set forth in this video will be realized. There is no guarantee that any historical trend referenced herein will be repeated in the future, and there is no way to predict precisely when such a trend will begin. 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.
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