September 23, 2023


The Nareit All Equity REIT Index was down 1.7% in March with office REITs (down 15.32%) suffering the worst declines. Several segments including infrastructure (up 2.7%), data centers (up 2.1%), self storage (up 1.9 percent) and industrial (up 1.2%) eked out gains. And for the year the index remained up 1.7 percent, as of the end of March.

The issues facing regional banks have also led to some concerns about the state of commercial real estate capital markets. Mortgage REITs were down 8.5% in March with home financing REITs down 6.4% and commercial financing REITs down 11.6%. Both segments are also in negative territory for the year, down 1.6% and 4.6%, respectively.

WMRE spoke with Edward F. Pierzak, Nareit senior vice president of research, and John Worth, Nareit, executive vice president for research and investor outreach, to discuss the state of mortgage REITs, the overall March results and other trends.

This interview has been edited for style, length and clarity.

WMRE: Let’s start with mortgage REITs, which is not a segment we’ve discussed in previous interviews. Can you give as a lay of the land?

John Worth: An important thing to keep in mind is there are two types. Residential mortgage REITs hold primarily agency, Freddie/Fannie backed mortgage-backed securities. Commercial mortgage REITs hold CMBS. Some also hold direct loans. There is more variety in the strategies on the commercial side.

When you look at them together, it is an interesting opportunity for individual and high-net-worth investors. Like equity REITs, mortgage REITs are playing the role of giving individuals access to an asset class that they would not otherwise have access to. In the RMBS sector, the vast majority of the loans mortgage REITs are holding are backed by Fannie and Freddie. They are riskless in terms of their credit profile and have performed well through a lot of different economic environment. Our expectations are that they will continue to perform well. Mortgage REITs paid out over $8 billion in dividends in 2022. That was up more than 15% over 2021. And they are currently yielding around 13.3%. So it’s a very healthy yield in terms of income payout and really attractive dividends to income-focused investors.

WMRE: How are these REITs affected by what’s happening with the banking sector?

John Worth: They’ve been affected by the overall rising rate environment. On their income statements they have had some unrealized and realized losses as interest rates have risen. Importantly, they are active in using hedging strategies to protect against changes in the shape of the yield curve and against large changes in interest rates. Even with that, interest rates are impacting their earnings. But they’ve maintained their dividends.

In terms of banking issues, any impacts will be second or third order. If we see RMBS sold on the market because of bank failures, it’s not great if you see a tremendous flow of new supply. However, it’s unlikely we will see that unfold in an uncontrolled way. So, it’s largely a non-issue for the mortgage REITs. Overall, it’s an interesting sector. It’s used by a lot of individuals and wealth managers for income-driven portfolios. And right now they are maintaining attractive yields.

WMRE: Pivoting to the equity REITs, it looks like overall the sector was down slightly. Office was the real outlier on the downside. Other property types were up or down by much smaller percentages.

Ed Pierzak: The results were slightly better than February. Overall the REIT total returns were down not quite 2%. The good news is year-to-date REITs are still up nearly 2%. In comparison to the broader equity market, the Russell 1000 is up over 7%. And REITs are well-positioned given their operational performance.

Office REITs were down a little over 15%. The story in office is the same as we’ve been talking about for a while. We’re in the midst of the experiment of hybrid work and work-from-home and that’s going to take some time to unravel.

WMRE: It feels like there’s been a recent uptick in sentiment that commercial real estate is on the verge of some kind of crisis and that’s garnered some attention in the broader financial press. But, aside from office, fundamentals for most other property types seem very strong. What do you make of this chatter?

Ed Pierzak: Even when you look at office REIT performance in terms of FFO and NOI, you are still seeing sold growth numbers. As we’ve said before, even if employees may not always be coming to the office, office tenants continue to pay their rents.

John Worth: Some of this also gets to the public vs. private valuation divide that we’ve talked about. For example, Morgan Stanley has estimates for how far commercial real estate values may fall that are around 40%. Our sense is that REITs have already priced in a lot of that adjustment due to higher interest rates. That’s part of where this private/public valuation gap plays a role. You can get a sense by looking at what’s happened to REITs already. Over the next 12 to 18 months, public and private markets will come together in terms or REIT valuations and private real estate prices.

WMRE: Does anything stand out with some of the other property sectors for the month?

Ed Pierzak: If look at top the performers, infrastructure, data centers and self storage are the top three. On a year-to-date basis, you also have self storage, industrial and data centers.

WMRE: We also just had the big merger announcement between Extra Space and Life Storage. That seems to underscore the strength in the sector and also seems consistent with recent deals in the REIT space that have been REIT-to-REIT combinations.

Ed Pierzak: Self storage offers consistent performance and fundamentals are good.

John Worth: If you look at last three or four years, 70% of mergers involving REITs have been REIT-to-REIT mergers. This deal has much of the same flavor. They are growing their platform, lowering their cost of capital and preparing for further growth in the sector.

WMRE: Nareit is getting ready to publish its annual ESG report. Can you talk about what we should expect to see?

John Worth: We do this to get a sense of what is going on in the disclosure world. There has been dramatic improvement in the last couple of years and this year is no different. The annual study looks at the public disclosures of the 100 largest REITs in terms of ESG. We’re going to be publishing this year’s data in the next couple of weeks. For the second year in a row, all 100 are publishing data on sustainability. It’s increasingly showing the ways that REITs are  leaders in sustainability in governance and in how they partner with their communities.

Today there are also 25 that are four- and five-star rated entities in GRESB’s metrics including 13 five-star rated REITS. For investors looking for high-quality, sustainable real estate to add to the portfolio, REITs can be part of that solution.

We’ve also got a dashboard that will show that out of the top 100 REITs, 73% are making public carbon goals and 83% are making public sustainability goals. And more than 87% are putting out carbon emission disclosures. That’s up dramatically from just four years ago when we first started covering this data. For sustainability, it has doubled since 2019 when the figure was 39% and for carbon goals it was 44%.

Reporting on social policies has also increased dramatically. In all, 96% are looking at suppliers, 99% on (diversity, equity and inclusion) and over 93% on health and safety. When we look at those disclosures, we’re going to have over 87% doing carbon emission disclosures.

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