The State of REITs: October 2023 Edition

0 out of 18 Property Types Yielded Positive Total Returns in September

100% percent of REIT property types averaged a negative total return in September, with a narrow 8.39% total return spread between the best and worst performing property types. Hotels (-2.77%) and Casinos (-3.41%) were the REIT property types with the smallest negative average total returns in September.

Office (-11.16%) and Land (-10.60%) saw even sharper declines than the rest of the REIT sector, averaging double-digit negative total returns in September. All 20 Office REITs were in the red as sentiment on the office sector remains very negative and data has not yet emerged to suggest a turnaround in fundamentals is coming anytime soon.

Performance of Individual Securities

Necessity Retail REIT (RTL) was acquired by Global Net Lease (GNL) on September 12th in a stock for stock transaction. Shareholders of Necessity Retail REIT received 0.67 shares of GNL for each share of RTL they held.

Power REIT (PW) (+20.83%) was the worst performing REIT in August, but partially bounced back with the highest total return in September. However, even after a strong September PW remains the 2nd worst performing REIT YTD with a dismal -70.63% total return.

Office Properties Income Trust (OPI) (-44.59%) announced on September 1st that they were terminating their planned merger with Diversified Healthcare Trust (DHC). This led to sharp declines for both REITs with DHC not fairing much better than OPI and finishing the month as the 2nd worst performing REIT of September (-28.55%) behind only OPI. The 3rd worst performing REIT, Industrial Logistics Properties Trust (ILPT) (-26.46%), is also managed by the same notoriously poor external management team at RMR Group (RMR) that manages OPI and DHC.

Only 9.74% of REITs had a positive total return in September with 34.38% in the black year to date. During the first 9 months of last year the average REIT had an awful -26.68% return. During the first 9 months of this year the average REIT has endured much smaller losses with a -6.54% 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 the highest dividend yield (as of 09/30/2023) to the 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 September and investors are now paying on average about 30% more for each dollar of 2023 FFO/share to buy large cap REITs than small cap REITs (15.7x/12.1x – 1 = 29.8%). As can be seen in the table below, there is presently a strong positive correlation between market cap and FFO multiple.

Bankruptcy filings in September increased month over month and remained elevated for the 10th straight month. The elevated number of bankruptcies in the first 3 quarters of 2023 is on pace to match the government lockdown-driven bankruptcy spike in 2020. With “higher for longer” now becoming the consensus for the fed funds rate, optimism is quickly fading for rate cuts to occur in the near term. This increases the odds that low interest rate debt coming due in 2024 will need to be refinanced at much higher rates. For businesses with poor balance sheets, this raises the risk of a bankruptcy filing.

However, the hotel industry is losing the battle with inflation as it contends with rapidly rising labor costs (+4.9% YoY in August) while ADR growth (+1.8%) fails to keep up with CPI growth (+3.7%).

The negative impact of decelerating ADR is further magnified by falling occupancy rates (-0.3% YoY in August). Midscale, Independent and especially Economy chains have endured declining demand in each of the past several months. This pain is not equally felt across the hotel sector, however, as Luxury, Upper Upscale and Upscale chains are all continuing to see strong demand growth.

Before considering investment in hotel REITs, it is very important to dive deep into the portfolio composition of each REIT in order to successfully identify which are well positioned to benefit from positive trends that exist within the sector, and which are likely to experience further deceleration of fundamentals. In this challenging economic environment, there is elevated opportunity for active managers to outperform REIT ETFs by capitalizing on widening fundamental differences between and within property types.

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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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