A Strong Recovery Is Underway In Commercial Real Estate, According To REIT Q2 Earnings
Hotel Milo, Santa Barbara, California
Courtesy of the Hersha Hospitality Trust
The recovery in commercial real estate accelerated this spring, according to REIT earnings reports for the second quarter. The result of all equity REITs, measured in terms of funds from operations (FFO), rose in 2021: Q2 by 19.8% compared to the previous quarter. Significantly, the REIT sector’s overall FFO rose slightly above its pre-pandemic peak and has fully recovered from the declines in earnings seen during the closings and social distancing last year (aggregate REIT earnings numbers are shown in the Nareit T- Tracker, a comprehensive measure of REIT profits and operating performance. Full Disclosure: I’m a Senior Economist at Nareit, helping create the quarterly T-Tracker).
REIT earnings have fully recovered from the declines at the start of the pandemic.
S&P Capital IQ Pro, Nareit T-Tracker.
This earnings recovery, while rapid, has been mixed across all real estate sectors, mainly due to the different experiences in the first year of the pandemic. Some sectors in the commercial property markets have been hit hard by the closings and social distancing measures over the past year. These COVID sensitive sectors include housing and resorts, retail (including regional shopping malls), and healthcare (including senior housing and skilled care facilities). The FFO of these sectors decreased by 40.8% from 2019: Q4 to 2020: Q4 (dark blue bars in the first chart).
Some sectors of commercial real estate benefited from the shift from physical interactions to digital during the pandemic. The increased use of online conference calls, email and data communications increased traffic for cell towers operated by the REIT infrastructure sector, as well as data centers that host Internet websites and store and transmit online communications. The goods that people bought online were often shipped through a logistics facility of the REIT industry sector. These REIT sectors of the digital economy recorded a 14.5% increase in FFO from 2019: Q4 to 2020: Q4 (light blue bars).
Other sectors, including office REITs, residential REITs, self-storage REITs, and others saw moderate profit declines over the past year, with FFO for these sectors declining 6.1% from 2019: Q4 to 2020: Q4 (gray bars ).
Of course, despite the rebound in REIT earnings, commercial property markets are still a long way from fully recovering. Occupancy rates remain low, especially for hotel, retail, office, and healthcare REITs. Occupancy will rise as the economy reopens, but at current speeds it will not fully recover until the end of 2022. In addition, an increasing rate of new cases of COVID-19 from the delta variant can cause setbacks that delay recovery.
However, the trend in real estate profits this year provides encouraging signs that the sectors that have borne the brunt of the closings caused by the pandemic are recovering faster than expected. Management teams from REITs across multiple sectors have indicated that they are signing new leases at record speed. Some REITs have reported collecting overdue rents that they previously wrote off as unlikely, suggesting that commercial tenants are also recovering.
Earnings growth is benefiting from rapid surges in the sectors hardest hit by COVID-19 over the past year. Retail REITs and accommodation / resort REITs accounted for almost half of the increase in FFO in the first half of 2021 (Chart 2). As new retail tenants continue to sign leases and travel volumes recover, revenues in these sectors should continue to grow.
Profits rose rapidly in retail and hotel / resort REITs.
S&P Capital IQ Pro, Nareit T-Tracker.
Investors have noticed the robust rebound in commercial real estate, and REITs are among the leading sectors in stock market returns this year. As of August 10, 2021, REITs had a year-to-date total return on investment of 24.7%, compared to the S&P 500’s annual return of 19.1%. REIT earnings have risen back to pre-pandemic yield levels and on course to continue to rise, REIT operational fundamentals support this stock market performance.