Taking The Pulse Of Public REITs

By Matthew Wolpert, CFA

As uncertainty clouds the coming year, there are a handful of themes we believe real estate investors should bear in mind.

In a world of macro cross-currents, we think there are several key themes public real estate investors should focus on in 2023:

1. Why the Fed stops hiking is more important than when it stops hiking. While the stock market has seemed excited by the prospect of the Fed concluding rate hikes in 2023, we believe that is only good if inflation is truly retreating toward the 2% target—and bad if in response to rising unemployment. Labor markets have remained strong this year despite tightening financial conditions, but it is not clear that can go on indefinitely, and we continue to worry monetary policy actions of 2022 could crimp growth in 2023.
2. With a potentially slowing U.S. economy and persistent inflation, it appears an attractive time to focus on real estate sectors with high-quality current cash flows and embedded future growth—namely in industrial real estate, digital infrastructure as well as select residential markets.
3. We believe that cap rates will be difficult to estimate in the near-term as the return of liquidity in the private market is likely to be slow, which means public market investors should focus more on multi-year cash flow forecasts and relative-value estimates than on spot absolute discounts to private market value.
4. Highly-levered balance sheets with pending maturities or exposure to floating-rate debt may continue to be a material risk in 2023, so beware the urge to take on excess leverage to drive returns off what may look like a bottom.
5. A combination of expanding rent rolls, we believe rising construction costs and declining new supply should lead to relatively healthy returns for real estate broadly—yet this multi-year story may benefit private markets more than public markets, as 2023 new supply is elevated in certain subsectors and public investors are likely to overstate the negative impact a recession would have on replacement costs.
6. Over a 12-to-24-month period, public REIT returns may outperform private-market real estate benchmarks, thanks to appraisal lag and growing redemptions in open-ended funds.
7. Debt securities with attractive absolute yields and equity subordination appear a compelling investment opportunity as they potentially provide protection from a decline in real estate values while generating current cash flow.

As we enter a year filled with uncertainty, we think a focus on price, growing cash flows and strong balance sheets will serve real estate investors well in 2023.

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