The State of REITs: January 2024 Edition

In December small cap (+13.39%) and mid cap REITs (+11.16%) averaged double-digit total return, exceeding the high single-digit returns of micro caps (+9.82%) and large caps (+9.55%). For full-year 2023, small caps (+13.30%) narrowly outpaced mid caps (+12.99%) and large caps (+11.92%). Micro caps (-26.44%), however, had a dismal year and fell 3,510 basis points short of the average REIT. Small caps outperformed large caps by 138 basis points in 2023.

17 out of 18 Property Types Yielded Positive Total Returns in December

94.4% percent of REIT property types averaged a positive total return in December. There was a massive 35.57% total return spread between the best and worst performing property types. Malls (+34.96%) handily outperformed all other REIT property types in December.

Infrastructure (-0.61%) was the only property type in the red in December, dragged down by the poor performance of CorEnergy Infrastructure Trust (CORR) (-23.91%), which more than offset the positive returns of Uniti Group (UNIT) (+7.26%), Power REIT (PW) (+6.51%), American Tower (AMT) (+4.21%) and SBA Communications (SBAC) (+2.73%).

The REIT sector as a whole saw the average P/FFO (2024Y) increase 1.2 turns in December from 12.5x up to 13.7x. The average REIT has now seen multiple expansion in 100% of property types in back-to-back months. Land (42.1x), Data Centers (24.8x), Timber (19.9x), Single Family Housing (19.3x), Industrial (19.2x), and Manufactured Housing (19.2x) currently trade at the highest average multiples among REIT property types. Malls (6.8x), Hotels (8.5x), and Office (8.6x) all average single-digit FFO multiples.

Performance of Individual Securities

RPT Realty (RPT) was acquired by Kimco (KIM) in an all-stock transaction with the closing announced before market on January 2, 2024. The final trading date for RPT was December 29th, the last trading day of 2023. RPT shareholders received 0.6049 shares of KIM for each share of RPT held.

Pennsylvania REIT (PRET) (+85.54%) saw a sharp spike upwards on the announcement on December 11th that although the current common and preferred shares will be cancelled in its Chapter 11 bankruptcy, shareholders will not be completely wiped out. Instead, preferred and common shareholders will each get a portion of a $10M payment. Despite the huge December gain, PRET finished the year with the 4th worst REIT total return in 2023 (-60.68%). Diversified Healthcare Trust (DHC) was the 2nd best performing REIT in December (+59.83%) and significantly outperformed all other REITs with an extraordinary +497.63% total return in 2023.

CorEnergy Infrastructure Trust (CORR) (-23.91%) fell sharply in December after being delisted from the NYSE on December 4th. CORR is still trading on the OTC marketplace. CORR’s brutal -83.25% total return in 2023, however, was only the 3rd worst REIT performance with even steeper losses seen by Power REIT (PW) (-83.55%) and Wheeler REIT (WHLR) (-97.81%).

90.79% of REITs had a positive total return in December with 66.25% in the black year to date. During full year 2022 the average REIT had a -23.56% return. The average REIT finished 2023 in the black with an +8.66% average total return.

Dividend Yield

Dividend yield is an important component of a REIT’s total return. The particularly high dividend yields of the REIT sector are, for many investors, the primary reason for investment in this sector. As many REITs are currently trading at share prices well below their NAV, yields are currently quite high for many REITs within the sector. Although a particularly high yield for a REIT may sometimes reflect a disproportionately high risk, there exist opportunities in some cases to capitalize on dividend yields that are sufficiently attractive to justify the underlying risks of the investment. I have included below a table ranking equity REITs from highest dividend yield (as of 12/31/2023) to lowest dividend yield.

REIT Premium/Discount to NAV by Property Type

Below is a downloadable data table, which ranks REITs within each property type from the largest discount to the largest premium to NAV. The consensus NAV used for this table is the average of analyst NAV estimates for each REIT. Both the NAV and the share price will change over time, so I will continue to include this table in upcoming issues of The State of REITs with updated consensus NAV estimates for each REIT for which such an estimate is available.

Takeaway

The large cap REIT premium (relative to small cap REITs) narrowed in December and investors are now paying on average about 28% more for each dollar of 2024 FFO/share to buy large cap REITs than small cap REITs (17x/13.3x – 1 = 27.8%). As can be seen in the table below, there is presently a strong positive correlation between market cap and FFO multiple.

The table below shows the average NAV premium/discount of REITs of each market cap bucket. This data, much like the data for price/FFO, shows a strong, positive correlation between market cap and Price/NAV. The average large cap REIT (-1.23%) trades almost on par with NAV. Mid cap REITs (-7.69%) trade at a high single digit discount to NAV, while small cap REITs (-20.97%) trade at just under 4/5 of NAV. Micro caps on average trade at less than half of their respective NAVs (-56.74%).

In December the number of bankruptcy filings reaccelerated and marked the 15th straight month of year-over-year increases in filings. 2023 had the most bankruptcy filings of any year since 2010, even exceeding the elevated number seen during the government-imposed lockdowns of 2020. With great uncertainty surrounding the timing and number of 2024 rate cuts by the Fed, struggling businesses will continue to face a challenging lending environment and it is likely that elevated bankruptcy filing will continue into Q1 2024.

Rising bankruptcy filings is certainly not the only concerning trend worth watching. The office vacancy rate rose to a new record high of 19.6% in Q4 2023, surpassing the prior record of 19.3% that had been reached in 1986 and again in 1991.

Although office vacancy has been trending upward since the beginning of the pandemic, this negative impact had been partially offset by 8 straight quarters (Q3 2021 – Q2 2023) of gains to effective rent. For each of the past two quarters, however, the sharp uptrend in office vacancy has instead been accompanied by declining effective rent changes, magnifying the pain for office landlords.

The Q4 2023 office vacancy rate increased by +0.4% quarter over quarter and +0.8% year over year. Although the asking rent per square foot did increase quarter over quarter in Q4 2023, the effective rent declined -0.3%. Despite negative effective rent changes in each of the past 2 quarters, the office sector did still see a +0.6% year-over-year increase.

This national data, of course, does not suggest that all markets are seeing the same trends. Some markets have seen a disproportionately severe deterioration of fundamentals, most notably San Francisco which saw both the largest increase in vacancy (+5%) and worst negative effective rent growth (-3.6%). Whereas other markets, such as Columbia (-4.0%) and Knoxville (-3.4%), have actually bucked this trend and seen vacancy rates materially improve over the past year.

This goes to show that it is important to follow both the overall trend and how individual markets and individual REITs compare to it. As office fundamentals rapidly declined nationally in 2023, office REITs appropriately underperformed on total return (+0.48% vs. +8.55%). However, office REITs with NYC-focused portfolios dramatically outperformed. SL Green Realty (SLG) (+48.41%), Empire State Realty Trust (ESRT) (+46.37%), and Vornado Realty Trust (VNO) (+39.24%) all outperformed the REIT sector by more than 3,000 basis points in 2023. With careful investment research and thorough due diligence, significant alpha can be achieved. A key part of that process is understanding fundamentals by market and knowing which REIT portfolios are positioned in the right markets.

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Past performance does not guarantee future results. Investing in publicly held securities is speculative and involves risk, including the possible loss of principal. Historical returns should not be used as the primary basis for investment decisions. Although the statements of fact and data in this report have been obtained from sources believed to be reliable, 2MCAC does not guarantee their accuracy and assumes no liability or responsibility for any omissions/errors

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Through October 2021, The State of REITs was published exclusively on Seeking Alpha by Simon Bowler, Sector Analyst at 2nd Market Capital Services Corporation (2MCSC).  Editions subsequent to October 2021 will be published on this website in addition to other platforms that may include Seeking Alpha.  2MCSC was formed in 1989 and provides investment research and consulting services to the financial services industry and the financial media. 2MCSC does not provide investment advice.  2MCSC is a separate entity but related under common ownership to 2nd Market Capital Advisory (2MCAC), a Wisconsin registered investment advisor.  Simon Bowler is an investment advisor representative of 2MCAC.  Any positive comments made by others should not be construed as an endorsement of the author's abilities to act as an investment advisor.

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