U.S. public REITs posted funds from operation of $21.0 billion—a 17.3% year-over-year gain—along with NOI growth of 5.2% to round out a strong third quarter, according to the latest Nareit REIT Industry Tracker.
In addition, occupancy rates for REIT-owned properties averaged 93.0%, led by retail (96.9%), followed by apartments (95.7%), industrial (94.5%) and office (85.3%).
In other REIT news, Nareit’s latest tracker of quarterly investment holdings for the largest actively managed real estate investment funds focusing on REIT investment found a surprising shift, with healthcare emerging as the largest allocation, surpassing the telecommunications and residential sectors. Overall, healthcare (which includes senior housing, medical offices and other healthcare-related properties) accounts for 18% of allocations in active funds.
Nareit also benchmarks the holdings of active funds against the composition of the FTSE Nareit U.S. Real Estate Index Series to gauge which sectors managers have overweight and underweight, relative to the index. By that measure, telecom remains the most overweight with an allocation of 135% in active funds compared with the index baseline.
WealthManagement.com spoke with Nareit’s Ed Pierzak, senior vice president of research, and Nicole Furnari, vice president of research, about the reports.
This interview has been edited for length and style.
Wealthmanagement.com: What stands out in the quarterly numbers?
Ed Pierzak: We continue to see solid operational performance across REITs. And when we look at their balance sheets, they are well-structured and exercising a lot of discipline.
If you look at FFO growth on a quarter-over-quarter and year-over-year basis, it was quite high–north of 17% on an annual basis. There are some things that are important to note on that.
FFO can be sensitive to individual stock or sector movements, and with this performance, it’s important to stress that we’ve had a very good quarter, but part of it is also when you look at the period of comparison, FFO in the third quarter a year ago was down quite a bit. There were some one-off issues. So comparing to that quarter led to seeing bigger gains.
However, if we try to control for outliers, the numbers are still strong.
WM: What about for other metrics?
EP: With NOI growth, you see the same thing. Year-over-year, it’s north of 5% growth. Getting into a sector analysis, we also see solid gains. And lastly, with same-store NOI, we see growth of 2.8%. That’s solid growth, albeit slightly less than inflation. But it’s an effort to provide an apples-to-apples comparison. However, only 7 of the 13 property sectors report same-store NOI, so it doesn’t give us a full view.
Occupancy rates, on average, came in at 93%. Of the four traditional property types, three are in proximity to 95% or better. Those are very strong numbers with office in the mid-80s. On the one hand, it’s a laggard, but it’s also a compilation of all office assets. Some are performing quite a bit better than others.
Lastly, on balance sheets, everything has stayed in line with how it’s been, with low leverage, just shy of 33%, weighted term-to-maturities still north of six years, and the cost of debt a little north of 4%. The vast majority of that is fixed rate—at over 90%—and over 80% is unsecured. It’s a competitive advantage not only in accessing, but also the cost of debt.
WM: How does the declining rate environment come into play?
EP: When we do see lower rates, we will see REITs get financing or do refinancing at lower rates. The competitive advantages don’t go away in a lower-rate environment.
WM: Pivoting to the latest active manager tracker study, what stands out?
Nicole Furnari: There were some interesting movements to analyze.
For a long time, residential had the largest allocation—going back to 2017. Last quarter, telecom, which had historically been underweight relative to the FTSE index, moved to parity and overtook residential as the largest allocation. But now in the third quarter, it’s healthcare, coming in at nearly 18% in U.S. actively-managed funds.
Telecom is still the most overweight by its index share. But healthcare has overtaken it in terms of absolute allocations. What that means is that funds didn’t sell off telecom and pass it to healthcare. There’s real strength in both of those sectors.
Also on the good news front, we see office is now overweight in actively-managed funds. We also saw a bump in specialty REITs in this quarter. We tend to think of that as Iron Mountain, which was a specialty business storage company that’s now moving into data centers. But in this quarter, it was because of a bit of influx into REITs that specialize in outdoor advertising (including billboards).
WM: Can you also talk a bit more about healthcare and what might be driving that allocation? Is it in part because of the larger demographics of aging baby boomers?
NF: That’s right. There are strong tailwinds driving demand, and we don’t foresee that changing. REITs have been savvy about building portfolios and adjusting to ensure they were in the right place at the right time. One of the pivots has been to build active adult communities, which straddle the line between straight residential and healthcare. They are communities only open to a certain age with some communal facilities, but the care level is minimal. The industry is trying to serve people at every stage of life in senior years.
