Margins are low, as operating expenses are high. Meanwhile, we dislike the hotel REIT business model generally, because hotel REITs are highly exposed to the cyclicality of the hospitality industry. While we're aware of the ostensibly attractive discounts to NAV, it is difficult to predict the degree of damage to be caused by heavy leverage, upcoming debt maturities, corporate layoffs, and the future of hybrid work. We remain cautious about office real estate. One way to answer is to look at which real estate sectors have become most undervalued relative to the private market valuation of their respective property types.Īs you can see, the five sectors of real estate that trade at the biggest discounts to the private market valuation of their properties are: That question could be answered in lots of different ways. Where are the best opportunities in the world of REITs? That creates fantastic opportunities for investors who are willing to swim against the tide Perhaps because REIT stocks are more heavily trafficked by retail investors than the largely even-keeled institutional investors that are heavy in other stock sectors, REIT prices tend to overreact both on the upside and the downside. Likewise, in 2020, REITs shed about 35% of their value, while the Green Street CPPI fell only about 13%. Note that in 2008-2009, the REIT index lost around 2/3rds of its value (~66%), and yet the Green Street CPPI shows that CRE property values only fell about 18% from their 2007 peak to their 2009 low! On average, REITs are about as discounted to NAV today as they were at the depths of the COVID-19 selloff, although they are not quite as discounted as they became in 2008-2009. Hence we now find ourselves at or near the shift in trends, from REITs becoming more and more discounted to NAV to REIT valuations normalizing as property prices come down and REIT prices come up. Office REITs, which have borne the brunt of the pain from deteriorating fundamentals and high debt, have already sold off heavily.The market is beginning to grasp REITs' resilience in the face of higher interest rates, given their stronger balance sheets than prior to the Great Financial Crisis.
Homebuying unaffordability due to high home prices and mortgage rates will keep many would-be homeowners in the rental market, benefiting residential REITs.The market widely anticipates the Fed to pause rate hikes soon and for this pause to be the end of the current rate-hiking cycle.What are some reasons why REIT prices could begin to rally even while the fundamentals are still under stress? REITs turned down and began trending lower around 6 months before CRE property prices began to fall. Why? Because for REITs, the market is trying to price in what is coming in the future, not the prevailing situation today.Īnd yet, the REIT index has dropped ~30% since its peak at the very end of 2021. This means that, at some point, REIT prices will turn back up and begin to rally even as actual property prices continue to trend down. Because of these factors, property prices tend to lag way behind "real-time" data like interest rates, while REIT prices significantly front-run the "real-time" data.īut everything in the market moves in cycles, including commercial real estate. Meanwhile, actual property prices rise or fall based on a number of factors, such as the amount of capital still available to be deployed, cost of new capital, the prices sellers are willing to accept, and so on. Investors are always trying to price in what is going to happen to real estate in the future - specifically, the foreseeable or near future. Publicly traded real estate stocks / REITs, like all other stocks, are forward-looking. Hence we find the wide discrepancy in performance between REITs ( VNQ) and the SPDR® S&P 500 Trust ETF ( SPY) over the past year:īut we will let you in on a little-known fact that we have learned from many years of paying close attention to both public and private real estate. Declining net asset values ("NAVs") as property owners mark-to-market falling property prices on their balance sheets.Higher vacancy rates due to a weakening economy and remote work.Higher interest rates, which will cause interest payments to soar.Real estate investment trusts ("REITs") have been absolutely pummeled over the past year or so as investors sold out in anticipation of a deep hit to cash flows from:
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