3 Questions CRE Investors Are Asking About REITs

REITs have been getting a lot of attention recently — like McDonald’s decision not to pursue a REIT spin-off and Fundrise’s proposed e-REIT. Even Congress is paying attention to REITs as noted by recently announced pending legislation to further regulate REIT spin off transactions.  But the trend of REITs opting for go-private transactions outranks them all.

“A trend in publicly-traded REITS going private is definitely upon us, and exists largely due to the fact that publicly traded REITs are trading below NAV,” confirmed Gil Menna, a Partner and the Chair of Real Estate Capital Markets at Goodwin Procter in an interview with VTS.

Here are 3 questions CRE professionals are asking to evaluate the near-term fate of REITs:

Does the wrapper matter?

“The interesting thing about the public REIT market is that, over the long term, the value of public REITs has been known to correlate to the value of the underlying real estate,” said Menna. “In the short term, however, publicly traded REITs generally correlate to S&P 500 and the broader stock market.” This result, in cyclical swings and the current environment, is a temporarily tough time for many real estate investment trusts which are trading below NAV as concern spreads about rising interest rates.

“Expressed another way: ‘does the wrapper matter?’ Over the long term, the wrapper doesn’t matter,” Menna added.

The REITs that are performing best in this environment are those that have access to private capital. Menna continued, “There are several public REITs that can leverage existing relationships with private capital sources and institutional investors, which helps them through times like these. It gives them access to capital to deploy without having to call on the public markets at depressed values in terms of per share NAV.”

Will interest rates continuously rise?

One of the biggest factors that will indicate the near-term fate of REITs is the anticipated rise in interest rates. The rise would likely cause an even further depression in value.

The rise in rates could come as early as the middle of this month. Yellen has already signaled that she is ready to raise short-term interest rates — assuming there is no dramatic turn of the economy. Many investors are preparing for a quarter-percentage-point increase in December.

The bigger question, arguably, is whether the upward movement in interest rates this quarter will be a one time event on a near and possibly longer term horizon. Menna explained, “It is extremely important for the REIT industry that investors believe that the tightening is here just today, and not again tomorrow. If investors feel rising interest rates are likely to continue into the foreseeable future, it will reinforce a short-term depression in REIT equity valuations. But again, this raises the question of ‘does the wrapper matter?’”

Will the GICS change matter?

In November 2014, S&P decided to shake up the GICS taxonomy a bit and move exchange-traded REITs into the newly created Real Estate sector. Although the change isn’t planned to take effect until August 2016, many industry pundits view the restructuring as a strong indication for REITs.   

When the news broke, Mike Kirby of Green Street Advisors remarked, “The...classification of real estate as a sector in GICS is a welcome validation of the fact that any diversified investment portfolio needs significant exposure to REITs. 

Menna agrees that institutional investors may become increasingly attracted to REITs as a source of capital with respect to both direct investments and with respect to joint venture investments as well.

Billy Fink
Billy Fink
Billy Fink is a former member of the VTS team. Subscribe to the VTS blog: https://blog.vts.com/
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