Strong recovery underway in commercial real estate, REIT Q2 results show
The recovery in commercial real estate accelerated this spring, according to second quarter REIT earnings reports. Profits of all REITs, as measured by funds from operations (FFOs), increased 19.8% in 2021: Q2 from the previous quarter. Significantly, FFOs in the REIT industry as a whole have slightly surpassed the pre-pandemic all-time high and fully recovered from the revenue declines seen during last year’s shutdowns and social distancing (the Aggregate REIT income figures are reported in the Nareit T-Tracker, a comprehensive measure of the REIT’s earnings and operating performance. Full Disclosure: I am a Senior Economist at Nareit and help produce the Quarterly T-Tracker) .
This profit recovery, while rapid, has been uneven across real estate sectors, mainly due to their different experiences during the first year of the pandemic. Some sectors of the commercial real estate markets have felt the full impact of closures and social distancing measures last year. These COVID-sensitive sectors include accommodation and resorts, retail (including regional shopping malls) and healthcare (which includes senior housing and skilled nursing facilities). The FFOs of these sectors decreased by 40.8% between 2019: Q4 and 2020: Q4 (dark blue bars in the first graph).
Some sectors of commercial real estate have benefited from the transition during the pandemic from physical interactions to the digital realm. The increased use of online teleconferencing, email and data communications has boosted traffic to cell phone towers operated by the REIT infrastructure industry, as well as data centers that host internet websites and store and transmit online communications. The goods that people bought online were often shipped through a logistics facility belonging to the industrial REIT sector. These digital economy REIT sectors saw a 14.5% increase in FFOs from 2019: Q4 to 2020: Q4 (light blue bars).
Other sectors, including office REITs, residential REITs, self-storage REITs and others saw moderate decline in profits last year, with FFOs in these sectors declining 6.1% from 2019. : Q4 to 2020: Q4 (gray bars).
Commercial real estate markets are far from fully recovered, of course, despite the rebound in REIT earnings. Occupancy rates remain low, particularly among hotel, retail, office and healthcare REITs. The occupancy rate is increasing as the economy reopens, but at current speeds it will not be fully recovered until the end of 2022. In addition, an increasing rate of new cases of COVID-19 from the Delta variant may result in setbacks that delay the recovery.
Real estate earnings trends this year, however, provide encouraging signs that the sectors that have suffered the brunt of the pandemic-induced closures are recovering faster than expected. REIT management teams across multiple industries have said they are signing new leases at an all-time high. Some REITs have said they perceive past-due rents they previously written off as unlikely to be collected, suggesting commercial tenants are also recovering.
Profit growth is benefiting from rapid increases among industries that had been most exposed to COVID-19 last year. Retail REITs and accommodation / resort REITs accounted for almost half of the increase in FFOs in the first half of 2021 (Chart 2). As new retail tenants continue to sign leases and travel volumes begin to rebound, profits should continue to rise in these sectors.
Investors have noticed the strong recovery in commercial real estate, and REITs have been among the top sectors in terms of stock returns this year. As of August 10, 2021, REITs had a cumulative total market return of 24.7%, compared to the cumulative return of 19.1% of the S&P 500. REITs earnings had returned to pre-pandemic earnings. levels and on track to continue to rise, the operational fundamentals of REITs are supporting this market performance.