Bad News For REITs: 8 Troubling Takeaways For Real Estate

Core Viewpoint - The REIT sector is facing significant challenges across various sub-sectors, leading to potential underperformance for some REITs in the near future, despite overall bullish sentiment towards REITs and commercial real estate stocks. Group 1: Apartment Market Challenges - The apartment market is currently oversupplied due to a surge in new developments following strong performance in 2021 and 2022, leading to declining occupancy rates and rents in many sunbelt markets [2][3] - Major apartment REITs like Mid-America (MAA) and AvalonBay (AVB) are forecasting minimal growth, with MAA predicting a 0.7% drop in same property NOI for 2024 and AvalonBay expecting only 1% growth [3] - BSR REIT reported a 19% year-over-year drop in NAV per share due to expanding cap rates, indicating a challenging outlook for the apartment sector in 2024 [3] Group 2: Self-Storage Sector Issues - The self-storage sector is also experiencing oversupply as demand moderates post-pandemic, with average occupancy rates declining to the low 90s, the lowest in a decade [5] - Major storage REITs like Public Storage (PSA) and Extra Space (EXR) are guiding for slightly declining FFO per share in 2024, despite significant price drops [5] - Opportunities exist in international markets, such as the UK, where Big Yellow Group has seen FFO per share growth of 7.4% in 2023, contrasting with challenges faced in the US [5] Group 3: Industrial Sector Rent Growth - The rapid rent growth in the industrial sector is moderating, with net absorption in the US dropping 61% in 2023 compared to 2022 [6][8] - Supply of industrial space is expected to grow at the highest rate in three decades, but construction starts have declined significantly, indicating a potential recovery in demand post-2024 [7][8] Group 4: Net Lease REITs and Inflation - Sticky inflation is posing challenges for net lease REITs, which are sensitive to interest rates due to long-term leases with limited rent hikes [9] - Realty Income (O) is highlighted as an example of a net lease REIT facing difficulties in growth due to low rent escalations and rising interest expenses [9][10] - Essential Properties Realty Trust (EPRT) is noted for its growth potential, with an 8% increase in FFO per share in 2023 and a forecasted 5% growth in 2024 [10] Group 5: Healthcare Sector Struggles - The healthcare property sector, particularly hospitals, is suffering from increased labor costs and reduced revenue from elective procedures, leading to tenant struggles [11] - Medical Properties Trust (MPW) is facing challenges with tenants making partial payments and potential bankruptcies [11] - Selectivity is crucial, with multi-tenant, purpose-built properties in medical clusters expected to perform better due to barriers to entry and demographic trends [12] Group 6: Mortgage REITs and Loan Issues - Many mortgage REITs are facing underwater loans due to high loan-to-value ratios established during low interest rate periods, leading to potential defaults [13][14] - KKR Real Estate Finance (KREF) recently cut its dividend in half as it prepares for losses, indicating the risks in this sector [14] Group 7: Capital Access and Debt Maturities - REITs raised significantly less equity in 2023 compared to 2022, which will slow growth in 2024 [15] - Realty Income (O) expects to make only ~$2 billion in acquisitions in 2024, down from nearly$10 billion the previous year [15] - A wave of debt maturities in 2024/2025 could impact commercial real estate, particularly for overleveraged private landlords, although most REITs are currently in a stable position [16][17] Group 8: Market Valuations and Opportunities - The REIT sector is trading at low valuations, near levels not seen since the financial crisis, presenting potential investment opportunities [18] - Notable examples include BSR REIT, Crown Castle (CCI), and NewLake Capital Partners (NLCP), which are all seen as undervalued despite strong fundamentals [18]