USRT - The Logical Fallacy Of REITs And CRE

2023-05-07 05:15:00 ET

Summary

• Just because corporate real estate has had its troubles, doesn't mean there aren't attractive opportunities within the listed-REIT space for diligent investors willing to look.
• Following the failures of Silicon Valley Bank and Signature Bank, concern rose that U.S. regional banks' ability to lend to the real estate sector may be impaired.
• We believe an end to the Fed's tightening cycle could support the REIT sector more broadly by providing greater clarity on financing and operating costs.

By Brian Jones

Pervasive pessimism in the corporate real estate sector may be clouding attractive opportunities among listed REITs.

Just because corporate real estate ((CRE)) has had its troubles, doesn't mean there aren't attractive opportunities within the listed-REIT space for diligent investors willing to look.

Following the failures of Silicon Valley Bank and Signature Bank, concern rose that U.S. regional banks' ability to lend to the real estate sector may be impaired. Regional banks - including recently seized First Republic - are sizeable lenders to U.S. CRE, with roughly $1 trillion in outstanding loans. Meanwhile, defaults within the Office sector have been on the rise thanks to hybrid-work trends, higher market vacancies, increased volatility in the financial industry, and greater scrutiny from lenders.

Yet we believe these clouds over U.S. CRE could be obscuring the outlook for the broader listed-REIT landscape.

Firstly, delinquencies appear to be largely ring-fenced within the Office sector, especially assets held by private, more-leveraged owners. And while many commodity (B-quality) office buildings may become obsolete, we think trophy-class A product will continue to see better rents and demand.

Secondly, the Office sector isn't the REIT bellwether it used to be. Given its weak performance over the past decade and the growth of emerging REIT sectors (such as Cell Towers, Data Centers, Single Family Rentals, and Casinos), Office represents less than 5% of most REIT benchmarks today. ¹ Additionally, we believe the better outlook and defensive cash flows for most of these other REIT sectors have the potential to hold up well in a recession.

Thirdly, we think challenges within the debt-capital and bank-lending markets will have limited impact given that listed REITs tend to finance with larger banks rather than regionals. Also, many REITs have well-positioned balance sheets, with about 35% leverage and 6x net-debt-to-EBITDA. ² And after refinancing at low rates over the last few years, many REITS have only about 6% of total debt due in 2023. ³

Finally, we believe an end to the Fed's tightening cycle could support the REIT sector more broadly by providing greater clarity on financing and operating costs.

Taken all together, we believe these observations paint an attractive picture for selective REIT investors. And with many REITs trading at double-digit discounts to NAV, it looks to us like much of the negative news may already be priced in.

Source: (1) Bloomberg: FTSE Nareit All Equity REITs (FNERTR) index weights; (2&3) Citi Research and Company Reports

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