In researching and conducting interviews on the REIT story I’m doing today in TV land, I’m struck by the vast disconnect between how well commercial real estate is actually doing and the expectations for REIT returns this year.
“We don’t see REITs getting to a new high this year- I think they’re probably going to test some new lows. And they could sit at discounts to their underlying asset values," says Citigroup REIT analyst Michael Bilerman. "We saw that in ’98 and ’99, where REITs traded at discounts to NAV – there just wasn’t that buyer to come in and move the group up. This sell-off has been a little different than prior sell-offs because the broad markets worked. And I think REITs have been, like other alternative asset classes, have been somewhere to hide out, as the broad market went through a period of correction.”
REITs have truly been phenomenal performers over the last seven years, up 25% on a compound annual basis. Commercial real estate has been on a tear, with investment up nearly 62% in the first quarter of this year from the same period a year ago. So why have REITs now fallen off their highs and suddenly expected to test new lows? Maybe some profit taking, but definitely some interest rate issues.
“What we’ve seen over the last few years in terms of prices being paid for real estate has continued to rise. So the yield that a buyer is getting has come down over the last few years," says Bilerman. "So “cap rate compression” has been the buzz-phrase over the last 5 years – we’ve seen cap rates decline from 9% to the 5’s. We’re now in an environment where potentially-–we haven’t seen hard evidence yet in the private market – that cap rates could begin to rise. Clearly with interest rates rising about 40 or 50 basis points since the beginning of the year and credit spreads on the debt that’s being arranged on some of these transactions is also up 30-40 basis points--–that’s going to feel the pinch on the ability for a buyer to buy assets.”
The fact of the matter is that there was nowhere to go but down for REITs. Compare their performance to the Dow over the last five years, and it’s no contest, with REITs up 160% versus the Dow’s 50%.
Paul Puryear of Raymond James just joined us in a discussion on air and said that while there is definitely a correction underway in REITS, he expects them to bounce back next year. Commercial real estate, unlike residential, is only growing, and REITs have far more cash to play with than, say, public homebuilders. This is of course why private equity has been saying “me likey” to REITs lately.