US REITs underperformed the broad market in November for the second consecutive month after three months of outperformance. So, it was the 16th time of weaker dynamics vs the broad market over the last 22 months.
EXECUTIVE SUMMARY
US REITs underperformed the broad market in November for the second consecutive month after three months of outperformance. So, it was the 16th time of weaker dynamics vs the broad market over the last 22 months. On an absolute basis, REITs ended the month in the green, for the 6th time over the last 7 months or for the 10th time over the last 13 months. Thus, the BBREIT index increased by 3.5% MoM in November vs +5.7% MoM of the SPX index. The absolute November performance was +0.5 std from the mean monthly performance, and it was in the top 27% of absolute monthly performance in the index history. In turn, the relative November performance was -2.2% MoM. It is -0.4 std from the mean, and it is in the bottom 31% of relative performance vs the SPX index since the BBREIT index inception. Moreover, the first decade of December wasn’t strong for US REITs either. Hence, the index increased only by 4.8% ytd vs +26.5% ytd of the SPX index as of December 10, 2024. Also, performance of the BBREIT index on relative basis during the first 11 months of 2024 still remained quite weak from the historical point of view, -0.7 std from the mean. US REITs remained volatile in 2024, but the volatility decreased notably in November, despite the ongoing 3Q24 earnings season as well as uncertainty of Trump’s election victory implications on the sector. So, dynamics of major CRE sectors remained mixed in November. However, the difference of monthly price changes between the best and the worst performers among top 50 REITs from the BBREIT index decreased notably, -12% MoM to 18.7% in November.
As a result of still weak both absolute and relative performance yoy, US REITs valuations remained depressed even despite notable reverse movement in recent months. Relative valuations vs the SPX index remained roughly flat on a yoy basis, staying near the lowest levels over more than 20 years. In turn, absolute valuations don’t look extremely cheap vs historical averages, given still elevated rates, even after their notable decline in recent months. Thus, P/B of the BBREIT index was 2.57x as of December 10, 2024, +0.57 std from the mean since April 2002, and +0.27x since the end of June 2024. P/Sales of the BBREIT index increased by 0.6x from the end of June to 6.61x as of December 10, 2024 vs an average since May 2002 of 5.6x. In turn, a discount to the SPX index on P/B was 51% as of December, 2024 vs the average discount since 2002 of just 22%, -1.8 std. As for P/Sales, the current premium to the SPX index was 114% vs the average premium of 218%, -1.6 std. On P/FFO basis, a median figure of REITs was 18.1x as of December 10, 2024 vs the historical average of 17.9x, or +0.1 std. In turn, median dividend yield of 50 largest BBREIT index members was 3.7% as of December 10, 2024 vs the historical average of 4.04%, or -0.3 std. On EV/EBITDA basis, a median figure of REITs was 20.1x as of December 10, 2024 vs the historical average of 19.9x, or +0.1 std, which is quite consistent with still relatively low financial risks of majority companies in the segment. As for individual names, multipliers are still quite different, but the dispersion across REITs has decreased significantly in the recent 2 years. Thus, median P/FFO estimates for offices were 11.3x/11.3x for FY24/25 as of December 10, 2024 vs industrial’s ratios of 19.4x/17.6x.
US economic outlook for the next year remains cautiously optimistic but uncertainty is still quite high. Thus, labor market indicators revealed during recent weeks were slightly better than expected after quite weak figures in October, driven by an impact of hurricanes, but even recent stronger figures indicated that gradual cooling of the labor market was on the track. Thus, payrolls increased by 227K in November vs the consensus of 220K, only the second beat over the last 5 months. So, average payrolls in 2024 were just 180K vs 251K in 2023. In turn, according to the household survey, total employment decreased by 190K MoM in November vs -220K in October. So, the unemployment rate increased by 10 bps MoM to 4.2% in November vs the consensus of 4.1%, already +50 bps yoy, and we expect it continues to go up in the near future. Inflation keeps going down, albeit at slower rate than in early months of the year. Nonetheless, even despite a miss in September, CPI was lower than expected (or in-line) in 6 of the last 7 months. On the other hand, it still remains above the Fed’s target. So, the FOMC has some room for maneuver in the near term, but the window of opportunities is short enough, given expected growth of inflation pressure from expected Trump’s changes to the economic policy. At least, interest expectations increased considerably in recent months. So, even another rate cut at the December meeting is under question at the moment, although it was perceived as a done deal just a few months ago. Quite high interest rates volatility in 2H24 indicate that economic uncertainty remains elevated. In turn, GDP growth forecasts were revised slightly up in November. So, it is expected that GDP growth will be around 2% in 2025/2026 years, notably lower than post-pandemic averages, but quite solid growth rate, given the current level of interest rates. Moreover, it is still expected that a recession in the nearest 12 months will occur with a probability of just 25%, the lowest figure over more than 2 years.
Another difficult year for CRE despite emerging fundamentals improvement is expected. Indeed, even a potential impact of Trump’s changes to the US economic policy will not be as positive for REITs as it will be for the majority of other industries, given tax-exempt nature of the former. At least, the BBREIT index underperformed the SPX index by 12.6% in 2017, the first year of Trump’s previous presidency, when a notable decline of corporate tax rate was announced. The impact of other promised changes to trade policy, immigration policy etc. on CRE also will be mixed, and it doesn't matter if the impact isdirect or indirect. In any case, the key risk is that potential acceleration of GDP growth due to economic policy changes will be the reason of a surge in inflation, following by rates growth, which were the key driver of REITs quotes in recent years. Thus, the correlation between average monthly 10yr treasury yield and the BBREIT index was -0.83 since the beginning of 2022, but it decreased notably in the last months. So, the better 3Q24 earnings season didn’t offset the negative impact of interest rate expectations growth in the first two months of 4Q24, even despite CRE was perceived as a relatively good inflation hedge and the fact that REITs leverage decreased notably in recent years. Thus, more than 75% of our sample of REITs reported higher revenue with a median surprise of +0.9%, and around 60% of the sample exceeded net income estimates with a median surprise of +3% vs +5% in 2Q24. Nonetheless, EPS/revenue estimates almost didn’t change since the start of 3Q24 reporting. On the other hand, gradual improvement of CRE fundamentals is on the track, and it will continue in 2025, albeit, perhaps, alittle slower thanexpected a fewquarters ago. Indeed, we expect gradual acceleration of both rent and NOI growth as well as lower vacancy rates, accompanied by higher absorption rates and lower pressure from the supply side, given lower construction activity. Nonetheless, trends will be mixed among CRE subsegments. Of note, the underlying property market also continued moving towards equilibrium recently. Thus, CPPI decreased just by 1.5% on a yoy basis in October, remaining roughly flat during the last 8 months, while transaction volumes still remain depressed across the board albeit bottoming out either. In turn, banks, the key source of CRE funding, continued tightening lending standards in 3Q24, albeit expecting further demand growth. But given current valuations and relatively weak revenue growth expectations for the nearest quarters, we don’t expect any significant outperformance of sector near term. So, we still remain neutral on the sector.
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