US REITs underperformed the broad market again in April 2023, for the third consecutive month, driven by office and industrial segments. Nonetheless, on absolute basis they ended the month in the green after two months of negative dynamics in a row. Thus, BBREIT index increased by 0.9% MoM within the month vs +1.5% MoM of SPX index.
EXECUTIVE SUMMARY
US REITs underperformed the broad market again in April 2023, for the third consecutive month, driven by office and industrial segments. Nonetheless, on absolute basis they ended the month in the green after two months of negative dynamics in a row. Thus, BBREIT index increased by 0.9% MoM within the month vs +1.5% MoM of SPX index. Absolute April performance was -0.1 std from the mean monthly performance, and it was in the bottom 45% of absolute monthly performance in the index history. April relative performance was -1.4% MoM. It is -0.3 std from the mean monthly performance, and it is in the bottom 38% of relative performance vs SPX index since BBREIT index inception. Despite the possible consequences of the recent banking crisis for the CRE market, REITs index still remains roughly flat ytd. Nonetheless, it continues underperforming the broad market ytd as it did in 6 out of 7 previous years.
As a result of weak absolute performance, valuations were roughly flat both MoM and ytd. Nonetheless, relative valuations vs SPX index still remains quite low, not very far from GFC’s troughs. On the other hand, absolute valuation doesn’t look extremely cheap vs historical averages. Thus, P/B of BBREIT index was 2.25x as of the end of April 2023 vs the average since April 2002 of 2.3x, -0.2 std. P/Sales of BBREIT index was 6.0x vs the average since April 2002 of 5.6x, or +0.3 std. In turn, a discount to SPX on P/B index was 45% as of the end of April 2023 vs the average discount since 2002 of just 19%, -1.7 std. As for P/Sales, a current premium to SPX index is 154% vs the average premium since 2002 of 227%, -1.1 std. On P/FFO basis, a median figure of REITs was 17.5x as of the end of April vs historical average of 18x, or -0.1 std.
Despite all the shocks that have befallen the US economy recently, it still continues to grow albeit at a below-trend pace. And the latter could be considered bad news if the word “recession” had not sounded so often during the last year. The labor market remains very tight, and it beat estimates again in April, implying that underlying fundamentals of the CRE market will not deteriorate as fast as CRE prices have fallen recently. Overall, macro data were slightly better than expected, but a mild recession is still the base scenario for 2H23 both according to the market consensus and the Fed projections. As it was expected, banks continued tightening lending standards for all types of CRE loans in 1Q23, but it didn’t affect underlying CRE fundamentals, at least so far. Thus, rent and same-store NOI growth continues at solid pace in all major segments, even in the office subsegment, which is perceived as the riskiest one at the moment. Moreover, CRE lending by commercial banks remained stable in recent weeks despite significant growth of risks, adding 10.3% yoy as of April 19, 2023. On the other hand, commercial property price index decreased by 1.3% MoM, or -8.0% yoy, as of the end of March 2023, -10% from its all-time high shown in July 2022. However, REITs estimates remain roughly stable ytd, albeit with relatively high dispersion among both trusts and subsegments. Thus, industrial CRE price index is still positive on yoy basis while apartment price decline continues accelerating.
REITs earnings remain resilient despite gradual deceleration of the economy, elevated inflation and still quite high interest rates. REITs noticeable underperformance in 2022 was caused by skyrocketing rates growth, but the rates themselves are not as destructive for REITs fundamentals as for CRE prices. So, estimates still remain resilient even despite an expected recession. The recent dynamics of fundamentals also sets us up for a positive mood. Nonetheless, price reaction on the recent banking crisis also implies that it is too early for investors to be bullish on the sector. So, we remain cautiously optimistic on the sector given current valuations, but recommend being selective and avoiding highly risky segments, such as office REITs.