In March 2023 the CBAI model portfolio achieved -4.07% vs -2.07% return for NAREIT benchmark. Overall, the CBAI model portfolio continues to outperform the NAREIT benchmark. The CBAI model portfolio outperformed NAREIT in 6 out of 12 monthly reporting periods. Since the start of the CBAI model portfolio in February 2021 the cumulative return has been 595% vs NAREIT return of 390%.
After the rebalancing analysis on February 15, 2023 the CBAI model holds positions in 23 REIT stocks with 38.2% of its portfolio in multifamily REITs with AvalonBay Communities (AVB), Equity Residential (EQR), and Mid-America Apartment Communities (MAA) being the largest holdings. Retail REITs constitute 24.2% of the portfolio with top REITs Simon Property Group (SPG), Regency Centers Corporation (REG), and Agree Realty Corporation (ADC). The third largest property sector is office REITs with 13.6% allocation (Boston Properties (BXP), Kilroy Realty Corporation (KRC), and SITE Centers Corp (SITC) are the largest holdings).
REITs Market Outlook
Some analysts are bullish on REITs and believe that REIT balance sheets are well-positioned to weather any economic storms, as investors have priced in a negative view of REITs last year, while private real estate is just starting to show declines.
Dick Wollack of Fulton Advisors and I have discussed the effects of interest rate increases on REITs in this article for IREI. We argue that REITs are not interest rate sensitive stocks. When you look at the data, not all high dividend stocks are highly interest rate sensitive. We argue that the current environment can actually be beneficial to REITs. Some of the reasons are lack of new construction, growth (interest rates grow because the economy is growing), inflation.
Residential Real Estate
The Fed’s interest rate hikes have caused the average rate on a 30-year fixed mortgage to rise to 7% in 2022, which has significantly impacted residential real estate sales, with existing home sales dropping for a record 12 straight months, according to the National Association of Realtors. Investment in housing has also fallen sharply in the GDP report.
The decline in single-family sales make builders switch to multifamily building, but in 2022 US has seen the highest rate of household formation in the last decade (the gap between single-family home construction and household formations grew to 6.5 million homes between 2012 and 2022). If we assume the rate will continue going up and the trend for underbuilding stays consistent, the long-term demand for housing will only continue to grow.
This trend makes an excellent case for multifamily REITs in the long run. However, it is important to keep in mind, that this gap figure overstates the housing shortage as multi-family rentals offer options for buyers and renters. When multifamily construction is included, the gap is reduced to 2.3 million homes. Also, as the for-sale single-family market slows down, the rate of housing starts would decline and the completed unsold inventory would most likely end up on the market as rentals, putting pricing pressure on multifamily rentals.
As of Q4’22 REITs report solid results and operating performance: strong balance-sheets with well-positioned debt with 80% of debt in fixed rate and longer maturity, increasing NOI and occupancy rates. All these factors present a strong buying opportunity for REITs investors.
Over the years, REITs have outperformed the broader market during periods of moderate and high inflation, while still providing competitive returns in periods of low inflation. In fact, since 1972, REITs have consistently outperformed the broad market during any time when inflation was above 2.5%. Historically, since 1972, the FTSE NAREIT All REITs Index’s average annual total returns totaled 11.9%, surpassing the S&P500’s 10.7%.
Over a 20-year period, REITs delivered an all-equity annual total return of 12.7%, compared to the S&P500’s 9.5%. Moreover, REITs outperformed private real estate funds by an average of 2% annually over the last 20-plus years. The five-year and ten-year growth rates for REITs were 12.4% and 12.2%, respectively, whereas private real estate grew at 7.7% and 9.4% for NCREIF.
Elsewhere in the economy
In Q4’22, the real GDP experienced a 2.7% annual growth rate, following a 3.2% increase in Q3’22. The growth in the fourth quarter was primarily driven by increases in inventory investment and consumer spending, although it was partly offset by a decline in housing investment. The annual inflation rate in the United States slowed to 5% in March 2023, which was in line with market forecasts and the lowest since September 2021. This was a decrease from 6.4% in January and 6% in February.
Despite the headwinds posed by the fight against inflation, the banking sector instability, several high-profile rounds of layoffs, and Russia’s war in Ukraine, the outlook for the US economy is improving due to a strong labor market, the covid impact wearing off, the early signs of the inflation finally going down (but not in all sectors), and robust household consumption and business investment. The concept of “US defaulting” is becoming a thing in the media again due to the political standoff over the debt ceiling. Economists predict a recession this year, but the National Association for Business Economics found in a survey that only a quarter of the respondents think a recession will have started by the end of March, down from half in December.
The Federal Reserve is facing a dilemma. While it wants to maintain credibility on inflation and avoid core inflation accelerating further, it also needs time to investigate the impact of recent bank collapses on financial conditions and reduce the risk of further financial instability. The biggest question for the Fed now is to decide how much more policy adjustment is needed and at what pace.
And of course there is a looming real estate debt crisis that might be brewing with recent Brookfield and Pimco defaults on their office towers. Vacant office buildings are still under 50% occupancy in many cities. It’s good to see that the mayors (NYC and DC) are finally beginning to take note and become more open to office-to-residential conversions.