Welcome to The Real Estate Reel from Cohen & Steers where we provide three insights on real estate investing in three minutes each month.
KEY TAKEAWAYS
- Private real estate has declined for the third consecutive quarter, and its sell-off is one indication of several we track that there may be an attractive entry point for listed real estate.
- Bank lending standards have also historically been a leading indicator for real estate, and recent data shows that a major net share of banks reported having tightened standards on all categories of Commercial Real Estate loans.
- Commercial real estate debt spreads are tightening, and this has been a recent tailwind for listed REIT returns as fears the market held in the spring have eased.
Transcript
Private real estate performance. Bank lending standards. And commercial real estate debt spreads. That’s what I am watching this month.
Welcome to The Real Estate Reel from Cohen & Steers where we provide three insights on real estate investing in three minutes each month.
First, 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, as you can see in this chart, listed REITs have increased for three consecutive quarters and now are up +13% as of the end of 2Q23 from their trough that was also in the third quarter of last year. That private peaked and listed troughed at the same time is not a coincidence. Listed REITs are a leading indicator for private valuations, both in a downturn and a recovery.
The sell-off in private is one indication of several we track that there may be an attractive entry point for listed real estate. The three recent quarterly declines in private real estate rank as the 5th, 8th and 9th greatest declines since 1978. When we look at the 10 prior greatest declines in the ODCE index, listed REITs have actually never been down over the next twelve months following those drops.
The second set of data I’m watching this month? It’s bank lending standards.
The Senior Loan Officer Opinion Survey on Bank Lending Practices, which is a quarterly survey of over 100 banks that the Fed conducts, showed that a major net share of banks reported having tightened standards on all categories of Commercial Real Estate loans. What I don’t think is getting enough attention is that lending standards stabilized during the second quarter. This was driven by large banks starting to loosen while smaller banks continued to tighten.
Lending standards have historically been a leading indicator for real estate, as we can see in this chart. Listed REITs have already declined in as they stood -23% below their prior peaks at the end of 2Q23 and were as low as -32% at their trough in 3Q22. The level of tightness indicated by the survey suggests that private property valuations could decline 20 to 25% in total. Typically, it takes 18 to 24 months for private to catch up to listed, though we expect it to be quicker this time.
Finally, commercial real estate debt spreads are tightening. As of the end of July, REIT spreads have tightened 42 basis points from the wide levels observed in March when bank failures sparked wider market concerns about the economy and possible contagion. Commercial mortgage-backed securities AAA spreads have tightened 55 basis points since then. The market is coming to terms with the fact that headwinds facing commercial real estate debt will be a slow burn over a longer period. But that’s better than a collapse that the market feared in March. As noted in this chart, tightening debt spreads have been a tailwind for listed REIT returns over the past couple of months.
Bottom line, we continue to believe that there are favorable entry points for listed real estate investors. And while private real estate valuations may have further to fall, we are beginning to see selective opportunities emerge.
So what will be watching next month? Use the link on screen to subscribe for our next Insight.
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
Plan asset diversification: Why real estate
Low correlations to stocks and bonds and other investment features can make REITs a prudent investment alternative for defined contribution plans.
Recent CRE transactions signal listed REIT strength
Listed REITs are now in a position to provide liquidity to the broader commercial real estate market.
As private real estate sells off, our conviction in REITs grows
Recent market events, including a downturn in private real estate, give us greater conviction in our analysis showing favorable entry points emerging for global listed REITs.
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.
This video is for informational purposes and reflects prevailing conditions and our judgment as of August 2023, which are subject to change. This material should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment. This material is not being provided in a fiduciary capacity and is not intended to recommend any investment policy or investment strategy or take into account the specific objectives or circumstances of any investor. We consider the information in this video to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of appropriateness for investment. Please consult with your investment, tax or legal professional regarding your individual circumstances prior to investing.
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.