Despite continued volatility and sell off across the REIT sector, green shoots are evident

CHICAGO, Nov. 16, 2022 – Despite a challenging capital markets environment and economic uncertainty, REITs continue to post strong earnings performance, with a substantial majority of REITs that have reported to date beating analyst estimates. Expectations are that in 2023 REITs will post positive NOI growth and stable occupancy across all major CRE sectors.

JLL’s latest M&A and Strategic Transactions Monitor dives into long-term themes driving the REIT market, including continued record amounts of dry powder, healthy underlying fundamentals and potential for renewed transaction activity driven by dislocations in the market as capital has repriced.

Public Market Themes

REITs are down approximately 22% year-to-date, driven by sustained inflation, Federal Reserve interest rate hikes and broader geopolitical risks. Despite possessing attributes that serve as a hedge against inflation, REITs have significantly underperformed the broader markets, down over 7% compared to the S&P 500 index. As a result, the REITs’ earnings multiple spread to S&P earnings is the lowest since the peak of COVID-19 around April 2020. It is not a surprise that REIT capital markets activity has ground to a halt as only $10 billion of follow-on equity issuance and $18 billion of unsecured notes offerings have closed to date; both significantly below 2021 activity.

“There is a disconnect between fundamentals REITs are experiencing and expectations in the marketplace, which is likely projecting an unhealthy economic scenario,” said Steve Hentschel, Head of JLL’s M&A and Corporate Advisory Group. “The trading performance seems harsh; however, it aligns with the persistent trading discounts to intrinsic value (NAV) experienced by most REITs and continues to challenge the notion that the public markets are an efficient vehicle for owning real estate assets and growing real estate companies.”

Given the unfavorable capital markets backdrop, M&A and strategic transaction activity has slowed dramatically. One potential catalyst for renewed M&A activity is that there is significant dry powder sitting on the sidelines; yet another is the continuing market dynamic that the trading of largest REITs has outperformed over the last few years, a trend accelerated in light of recent volatility; this disparity in market currency may serve as a catalyst for increased M&A activity if sub-sector valuation gaps persist during 2023 and 2024.

“Recent REIT mergers closed since 2020 have generated positive shareholder returns,” said Sheheryar Hafeez, Managing Director of the M&A and Corporate Advisory Group within JLL Capital Markets. “Investors have rewarded acquirers with share price outperformance versus peers, which is an encouraging data point for other REIT executives evaluating merger activity.”

The outlook for take-private activity in the short term is not as positive given the relative lack of availability for large loans (critical for take-privates) and historically high interest rates now approaching 7% given continued Fed Funds rate hikes this year to curb inflation. However, the combination of significant dislocation in REIT valuations when compared with NAV and the presence of the wall of capital raised, are potential catalysts for activity down the road when debt markets bounce back.

“Dedicated real estate funds targeting commercial real estate have amassed over $250 billion in equity,” added Hafeez. “The wall of capital is approximately three times greater than the one that existing during Global Financial Crisis and there will be pressure to deploy the capital once we emerge from the current volatile environment.”

Not surprisingly, REIT senior unsecured note yields have increased to over 5.5% from below 2.75% in January 2022. The weighted average interest rate on existing REIT unsecured debt, which comprises 70% of total debt on REITs’ balance sheets is approximately 3%. Despite interest rate driven headwinds, REITs are relatively well-placed given limited maturities through 2024 across most sectors. Additionally, for those loans that do mature, REITs are equipped with sufficient dry powder ranging from 17% to 31% and boast strong interest coverage ratio of approximately 7x. REITs, over recent years, have been judicious with the use of leverage and have positioned themselves to weather the headwinds effectively.

Private Market Themes

After hitting record prices that may have seemed unsustainable for the long-term, the widespread repricing of transactions has brought going in yields back to late 2019 levels for the most part. Current going-in yields for core or core-plus projects range between 4% for multi-housing and up to almost 7% for office. In addition, a meaningful bid-ask gap has developed between buyers and sellers. Unlike REIT unsecured bond markets, the private debt markets continue to be open, albeit muted, and it is anticipated that loan demand will bounce back in 2023 and 2024 given the underlying strength of real estate fundamentals.

JLL Capital Markets is a full-service global provider of capital solutions for real estate investors and occupiers. The firm's in-depth local market and global investor knowledge delivers the best-in-class solutions for clients — whether investment sales and advisory, debt advisory, equity advisory or a recapitalization. The firm has more than 3,000 Capital Markets specialists worldwide with offices in nearly 50 countries.

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