The worst appears to be behind the listed REIT market, and there is potential for the listed rally to continue. Private real estate, by comparison, is expected to sell off further.
KEY TAKEAWAYS
- Full-year 2023 net total returns for private real estate fell to nearly -13% after a fourth quarter selloff while listed REITs were up nearly 12% last year.
- We believe private commercial real estate price returns will likely trough at around -25% in late 2024, but the worst is behind the listed REIT market, and there is potential for the listed rally to continue.
- The Q4 rally in listed REITs is neither long or particularly pronounced relative to historical rallies, and we believe REITs are also in a position to become net acquirers of properties.
Transcript
Declines in private real estate. The rally in listed real estate relative to history. And listed REIT premiums to net asset values.
That’s what I’m watching this month.
Welcome to the Real Estate Reel from Cohen & Steers.
First, I’m watching declines in private CRE valuations that occurred in the fourth quarter of 2023.
The NCREIF ODCE index, which tracks around 25 open-ended funds that own core commercial real estate, was down 5 percent in the fourth quarter. By comparison, listed REITs were up nearly 18 percent in the last three months of 2023.
Declines in private real estate
Private real estate values will likely fall further in 2024 – 2025 if listed REITs are an indicator
December 31, 2023. Source: NCREIF, Bloomberg, Cohen & Steers.
Data quoted represents past performance, which is no guarantee of future results.
This brought full-year 2023 net total returns for private real estate, again as measured by the NCREIF ODCE index, to nearly negative 13 percent while listed REITs were up nearly 12 percent last year.
This may seem like a significant disconnect, but listed REITs are leading indicators for private real estate in both downturns and recoveries. Indeed, listed REITs were down 25 percent in 2022 while private real estate was still up almost seven percent during that same period.
Similarly, listed REITs were down as much as 30 percent from their peaks in late October of last year while private commercial real estate is currently only down 17 percent from its prospective perspective peak. In other words, the private commercial real estate markets are still catching up to what’s in the price of listed REIT valuations.
We believe private commercial real estate price returns will likely trough at around negative 25% in late 2024, but the worst is behind the listed REIT market, and there is potential for the listed rally to continue.
This brings me to the second point I’m watching: The current listed real estate rally relative to history.
Listed REITs are more than 20% above their late October ’23 trough.
There have been 13 prior rallies that have risen in total returns of more than 10 percentage points without a pullback from peaks of greater than 10 percent, which you can see in this chart. Those rallies have averaged almost 69% and lasted an average of 21.5 months.
The listed rally relative to history
Current REIT rally is not long or pronounced compared to history
At December 31, 2023. Source: Bloomberg.
Data quoted represents past performance, which is no guarantee of future results.
The shortest rally lasted 11 months. Only one rally ended at lower cumulative returns than the 25% rally we saw to end last year. In other words, this rally is neither historically long or particularly pronounced.
That said, the current rally is the second greatest two-month rally on record. It only trails the February ’09 rally when listed REITs rose 36% after two months, which we don’t think is a relevant comparison to today as it was aided by Fed monetary stimulus during the Great Financial Crisis.
We believe it’s possible that valuations could pull back 5-7% from local peaks, given the magnitude of the recent rally. Such consolidation often occurs during rallies. For context, the greatest pull back from peak during a rally was -8% in December 2018.
We believe investors should be buyers of listed REITs in the event of a pullback. We highlight that the sector stands almost negative five percent below their local peaks in late 2023 as of January 26, 2024.
The third point I’m watching is listed REIT premiums to their net asset values. Based on Green Street data, NAVs have risen from discounts of negative 16 percent toward the end of October 2023 to premiums of almost 8% percent toward the end of January 2024.
On the surface, this might suggest that listed REITs are expensive to private market valuations, but we think the premiums indicate that markets may finally be giving the sector the so-called green light to begin net acquiring assets. As you can see in this chart, listed REITs have been net sellers of asset since 2015. The shift stands to reason. Public markets force discipline on listed REITs by having them to sell assets when private valuations are expensive and then buy assets when private valuations begin to cheapen.
REIT premiums to net asset values
Listed REITs have historically acquired assets in similar market conditions
At December 31, 2023. Source: Green Street, Real Capital Analytics, Cohen & Steers.
Data quoted represents past performance, which is no guarantee of future results. There is no guarantee that any historical trend illustrated above will be repeated in the future, and there is no way to predict precisely when such a trend might begin.
(1) Net Acquisitions by buyer type are as of September 30, 2023.
(2) Listed real estate represented by the FTSE Nareit All Equity REITs Index which contains all tax-qualified REITs with more than 50% of total assets in qualifying real estate assets other than mortgages secured by real property that also meet minimum size and liquidity criteria.
We’ve seen this movie before. During 2000 to 2004 and again in 2010 to 2014, listed REITs net acquired assets as premiums to NAVs afforded them an attractive cost of capital. We think this scenario can happen again, especially because listed REITs can issue debt at much more attractive levels via the senior unsecured market. Where s private peers that must rely primarily on mortgage financing.
If listed REITs start acquiring assets, then their earnings will grow, and their valuations may not be as expensive as perceived on the surface.
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Watch January 2024 The Real Estate Reel: European real estate investing – Three data points we’re watching now
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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
Why invest in listed REITs today
REITs have outperformed stocks and bonds when yields and growth move lower. Demand is healthy while supply is constrained. And REIT valuations relative to the broader equity market are meaningfully below the historical median.
The Real Estate Reel: A closer look at Q1 REIT returns and what may be next
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.
3 Reasons to own listed REITs today
We see compelling evidence to own listed real estate in the current environment.
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 January 2024, 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.
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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