REITs Are Recovering But Some Are on Shaky Ground

“The major concern is, what does the future hold? Will work from home prevail, or will commuting to the office return? That’s a debate that will play out over the next several years.”

(Simon Dawson/Bloomberg)

(Simon Dawson/Bloomberg)

REITs remain resilient.

A survey conducted in June by Natixis Investment Managers of 300 U.S. financial advisors revealed that among alternative investments, REITs were most popular. And 68% of those surveyed include REITs as part of their client portfolios.

The National Association of Real Estate Investment Trusts (NAREIT) says that advisors invest in REITs for several reasons including diversification, performance, dividends, and inflation protection.

But the pandemic has punished REITs, particularly those with commercial and tenant leases as many employees now work remotely. There has also been an exodus of tenants from urban centers to suburbia. In addition, the pandemic contributed to mortgage-backed securities losses and a decline in value of mortgages not guaranteed by Fannie Mae or Freddie Mac.

Advisors are now debating if the worst is over.

At the same time, the traditional portfolio mix of 60% stocks and 40% bonds is facing headwinds, namely bonds. With interest rates near zero, REITs, which regularly yield 4%, are getting a closer look from income seekers who historically might have preferred bonds.

NAREIT’s All Equity REIT index reached its low point on March 23 when it was down as much as 37.6%. By August 31, it was down 9.8%.

[Like this article? Subscribe to RIA Intel’s’ twice-weekly newsletter.]

“REITs have rebounded significantly since their lows,” says John Worth, executive vice president of Research and Investor Outreach of NAREIT.

Since March, the recovery has been broad. Worth notes that industrial, retail, healthcare, and data center REITs have increased 20% since then. Moreover, residential, diversified and self-storage REITs rose between 10% and 20% in that period. Only office REITs have gained less than 10% since then and no sectors have declined.

Worth says “The REIT recovery has tracked reopening of the economy and the realization that, in many sectors, rent payment performance exceeded expectations.”

He noted that 95% of commercial tenants have been steadily paying their rent. “But the major concern is, what does the future hold? Will work from home prevail, or will commuting to the office return? That’s a debate that will play out over the next several years,” Worth says.

“This is an uncertain environment.” But REITs are better positioned than in the past, use less leverage, have less debt, and have greater access to cash and equity on their balance sheets, he emphasizes.

Given all the uncertainty, the concern about people’s health and well-being and reluctance to return to the office, can REITs bounce back? Worth replies that this sense of confidence is inextricably linked to the “broader economy and people being confident they can go about their daily lives without putting themselves or others at risk.”

Michael Bapis, New York-based managing director at Vios Advisors at Rockefeller Capital Management, acknowledges that the “public perception that people weren’t going back to their offices” affected the value of most commercial retail REITs.

But many financial advisors continue to recommend REITs as part of their clients’ retirement portfolios. Advisors view investing in them as a “value play. Working from home can only last so long. They’re missing camaraderie and communication, particularly in sales jobs,” Bapis explains.

There’s also some worry that long-term remote working could harm performance. BlackRock CEO Larry Fink said last week he was concerned that creative ideas aren’t as free-flowing during meetings by video conference, at least compared to the office hallway or watercooler. He also wonders if the 400 new BlackRock analysts hired this year — who have never been to the office — will have or maintain the largest asset manager’s company culture.

Other companies that feel the same way might mandate that employees return to the office after the pandemic.

In addition, most REITs have maintained their dividends. Some yield 6% or 7%, which is hard to resist, Bapis notes, particularly in a zero interest rate environment. (REITs must distribute at least 90% of taxable income as dividends to investors.)

Moreover, he expects some consolidation among commercial retail REITs. The leaders with “strong balance sheets and tax flow will weather the storm.”

Bapis expects the value of many REITs to remain volatile over the next 12 to 18 months. “But we’re going to have a recovery and they will go higher. If you can stomach the volatility, there’s value in investing in the REIT sector,” Bapis notes. He describes the key traps in the REIT sector as rent collection and financing.

“If you have the right properties in the right locations, they’ll survive and thrive,” he states.

Tara Fung, Nashville-based chief revenue officer at AltoIRA, which specializes in diversifying retirement savings with investments in start-up companies, real-estate, and digital assets, says that “the public market uncertainty makes private markets more attractive and more important.” Since AltoIRA acts as a custodian, it’s seeing “more clients of advisors self-sourcing deals on their own,” Fung says.

This year’s market volatility hasn’t reduced demand for REIT investing in IRAs, Fung notes. Choosing an IRA is a “long-term funding vehicle. You can’t touch an IRA until you reach a certain age,” she notes.

The value of REITs took a hit at the onset of the pandemic because “investors look at REITs and had the expectation that earnings are going down because of the slow economy,” explains Glenn Mueller, a professor of real estate at Denver University, who studies the industry.

Interest in REITs remained strong because many advisors were confronted with the stark reality that a 10-year bond earned less than 1% while REITs regularly offer 4%, Mueller says.

Moreover, most REITs invest in class A properties that have risen in value during the pandemic, not Class C and D properties that have faltered, points out Mueller. In fact, he says most ecommerce companies like Amazon are looking for more commercial space and properties to meet their burgeoning needs. That should boost the value of commercial REITs in the near term, at the least.

Advisors have largely stuck with REITs despite the slowdown in many sectors, says NAREIT’s Worth. Most invest “for the long-term; they understand you’re going to have years when you’re up and years when you’re down.”

Subscribe to RIA Intel’s twice-weekly newsletter and follow the publication on Twitter and LinkedIn.